9.3 Lessor Accounting and Reporting

Lessor accounting involves classifying leases as sales-type, direct financing, or operating. Each type has distinct recognition, measurement, and income calculation methods. Understanding these differences is crucial for accurately reporting lease transactions in financial statements.

Lessors must evaluate lease classification criteria, record appropriate journal entries, and present lease-related information in financial statements. This includes recognizing net investments in leases, calculating lease income, and disclosing key details about leasing arrangements and associated risks.

Lease Classifications for Lessors

Sales-Type Leases

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• Transfer control of the underlying asset to the lessee
• Lessor expects to derive a profit from the lease in addition to interest income
• Fair value of the leased asset is different from its carrying amount
• Example: Lessor leases a piece of equipment with a fair value of $100,000 and a carrying amount of$80,000 for a term that covers a major part of the asset's economic life

Direct Financing Leases

• Transfer control of the underlying asset to the lessee
• Lessor does not expect to derive a profit from the lease other than interest income
• Fair value of the leased asset is the same as its carrying amount
• Example: Lessor leases a vehicle with a fair value and carrying amount of $30,000 for a term that covers a significant portion of the vehicle's economic life

Operating Leases

• Do not transfer control of the underlying asset to the lessee
• Lessor retains substantial risks and rewards associated with the ownership of the leased asset
• Example: Lessor leases office space for a term of 3 years, which is significantly shorter than the building's economic life of 30 years

Lease Classification Criteria

• Evaluate the transfer of ownership
• Assess the existence of a purchase option
• Compare the lease term to the economic life of the asset
• Calculate the present value of lease payments in relation to the fair value of the asset
• Determine the specialized nature of the asset

Lease Recognition and Measurement

Sales-Type Leases

• Lessor derecognizes the leased asset
• Recognizes the net investment in the lease (lease receivable and unguaranteed residual asset)
• Records any selling profit or loss
  • Lease receivable measured at the present value of the lease payments not yet received, discounted using the rate implicit in the lease
  • Unguaranteed residual asset measured at the present value of the amount the lessor expects to derive from the underlying asset following the end of the lease term

Direct Financing Leases

• Lessor derecognizes the leased asset
• Recognizes the net investment in the lease (lease receivable and unguaranteed residual asset)
• No selling profit or loss is recorded

Operating Leases

• Lessor retains the leased asset on its balance sheet
• Does not record a lease receivable or unguaranteed residual asset

Lease Income Calculation

Sales-Type Leases

• Lessor recognizes interest income on the net investment in the lease using the effective interest method
• Recognizes any variable lease payments and impairment losses
• Effective interest method allocates interest income over the lease term on a systematic and rational basis, producing a constant periodic rate of return on the net investment in the lease

Direct Financing Leases

• Lessor recognizes interest income on the net investment in the lease using the effective interest method
• Recognizes any variable lease payments and impairment losses

Variable Lease Payments

• Payments that depend on an index or rate are included in the measurement of the net investment in the lease using the index or rate at the commencement date
• Changes in variable lease payments are recognized in profit or loss in the period of the change

Journal Entries for Leases

Sales-Type Leases

• Initial journal entry:
  • Debit lease receivable and unguaranteed residual asset
  • Credit leased asset
  • Credit any selling profit (or debit selling loss)
• Subsequent journal entries:
  • Debit cash and credit lease receivable for lease payments received
  • Debit interest income and credit lease receivable for interest earned

Direct Financing Leases

• Initial journal entry:
  • Debit lease receivable and unguaranteed residual asset
  • Credit leased asset
• Subsequent journal entries:
  • Debit cash and credit lease receivable for lease payments received
  • Debit interest income and credit lease receivable for interest earned

Operating Leases

• No initial journal entry required (leased asset remains on lessor's books)
• Subsequent journal entries:
  • Debit cash and credit lease income for lease payments received

Impairment Losses

• Debit impairment loss and credit lease receivable for any impairment losses on the net investment in the lease

Lease Presentation in Financial Statements

Balance Sheet

• Sales-type and direct financing leases: Present net investment in the lease (lease receivable and unguaranteed residual asset)
• Operating leases: Leased asset remains on the balance sheet

Income Statement

• Sales-type and direct financing leases: Present selling profit or loss (if any), interest income, variable lease income, and impairment losses
• Operating leases: Present lease income

Statement of Cash Flows

• Operating leases: Present lease payments received as operating activities
• Sales-type and direct financing leases:
  • Present principal portion of lease payments as investing activities
  • Present interest portion as operating activities

Disclosure Requirements

• Describe the nature of leasing arrangements
• Disclose significant judgments made in applying the leasing standard
• Present the components of the net investment in the lease
• Provide a maturity analysis of lease receivables
• Disclose information about how the lessor manages its risk associated with the residual value of leased assets