Accounting for Leases

Lease Type

Characteristics

Lessor Treatment

Lessee Treatment

Direct Financing Lease (or Capital Lease)

Lessee obtains substantially all the benefits and risks of ownership. ie bargain purchase options or lessor assured 90% or more of investment + rate of return

Investment in the lease is shown as a receivable and the profit as deferred income. Deferred income is taken into revenue over the life of the lease

Both the asset value and the obligation are capitalized based on present value. On the P&L the lease is amortized much like depreciation & implicit interest expensed much like a loan

Sales Type Lease

Similar to a Direct Financing except the FMV may differ from carrying amount

Same as Direct Financing except the profit or loss from "selling" the asset to the lease "portfolio" must be recognized at the time of transaction

Same as a Direct Financing Lease

Operating Leases

The present value of the rental stream together with residual value guarantees is less than 90% of the lessor's investment in the lease. PV is calculated using the lower of the lessor's incremental borrowing rate and the before tax rate of interest implicit in the lease. The term of the lease is less than 75% of its economic life.

Cost of equipment is included as a capital asset. Rent is treated as income and depreciation as an expense. Any initial direct costs must be amortized over the term of the lease.

Rentals charged to income as incurred