CHAPTER 41

FINANCE LEASE – LESSOR

QUESTION 41-1
Contrast a sales-type lease from a direct financing lease.

ANSWER41-1
Lessors classify a finance lease either as sales-type or direct financing lease.

1. The primary difference is the recognition of a manufacturer’s or dealer’s profit or loss.

The sales-type lease recognizes a manufacturer’s profit or loss. The direct financing
lease does not.

2. Both sales-type and direct financing leases recognize interest income or financial
revenue.

QUESTION 41-2
Explain the following in connection with a “direct financing lease”:

1. Gross investment
2. Net investment in the lease
3. Unearned interest income
4. Initial direct cost

ANSWER 41-2
1. Gross investment – This is equal to the gross rentals for the entire lease term plus the
absolute amount of the residual value, whether guaranteed or unguaranteed. Actually,
this is the amount debited to lease receivable.

2. Net investment in the lease – This is equal to the cost of the asset plus any initial direct
cost incurred by the lessor.

3. Unearned interest income – This is the total financial revenue of the lessor which is the
difference between the gross investment and net investment in the lease.

4. Initial direct cost – In a direct financing lease, the initial direct cost incurred by the
lessor is added to the cost of the asset to get the net investment in the lease.

This would effectively spread the initial direct cost over the lease term and reduce the
amount of interest income.

Accordingly, the interest rate implicit in the lease is recomputed so as to include the
initial direct cost in the measurement of the lease receivable.
QUESTION 41-3
Explain the following in connection with a “sales type lease”.
1. Gross investment
2. Net investment in the lease
3. Unearned interest income
4. Sales
5. Cost of sales
6. Gross profit
7. Initial direct cost

ANSWER 41-3
1. Gross investment – This is equal to the gross rentals for the entire lease term plus the
absolute amount of the residual value, whether guaranteed or unguaranteed.

Recall that this is the same definition of gross investment in a direct financing lease.

2. Net investment in the lease – This is equal to the present value of the gross rentals
plus the present value of the residual value, whether guaranteed or unguaranteed.

3. Unearned interest income – This is the total financial revenue of the lessor which is the
difference between the gross investment and net investment in the lease.

4. Sales – The amount is equal to the net investment in the lease or fair value of the asset,
whichever is lower.

5. Cost of sales – This is equal to the cost of the asset sold plus the initial direct cost
incurred by the lessor.

6. Gross profit – This is the usual formula of sales minus cost of sales.

7. Initial direct cost – This amount is expensed immediately in a sales type lease as
component of cost of sales.

QUESTION 41-4
Explain the “actual sale” of the leased asset by the lessor to the lessee.

ANSWER 41-4

When a lessor actually sells an asset that it has been leasing under a finance lease, the
difference between the selling price and the carrying amout of the lease receivable is
recognized in profit or loss.

The carrying amount of the lease receivable is equal to the balance of the lease receivable
minus the unearned interest income.
For example, an entity sold an equipment that it had been leasing under a direct financing
lease for P3,500,000. The following balances are associated with the finance lease on the
books of the lessor on the date of sale:

Lease receivable 5,000,000

Unearned interest income 1,200,000

The following computation is necessary:

Sales price 3,500,000

Carrying amount of lease receivable:
Lease receivable 5,000,000
Unearned interest income ( 1,200,000 ) 3,800,000

Loss on sale of leased equipment ( 300,000)

QUESTION 41-5
What are the disclosures required in a finance lease on the part of lessor?

ANSWER 41-5

1. A reconciliation between the gross investment in the lease and the present value of the
minimum lease payments receivable at the end of reporting period.

2. The gross investment in the lease and the present value of the minimum lease
payments receivable at the end of reporting period for each of the following periods:

a. Not later than one year

b. Later than one year and not later than 5 years
c. Later than 5 years

3. Unearned finance income or unearned interest income.

4. Unguaranteed residual value accruing to the benefit of the lessor.

5. Accumulated allowance for uncollectible minimum lease payments receivable.

6. Contingent rent recognized as income in the period.

7. A general description of the lessor’s material leasing arrangement.

QUESTION 41-6 Multiple choice (IFRS)

1. Gross investment in the lease is

 -a. Aggregate of the minimum lease payments under a finance lease of the lessor and
any unguaranteed residual value accruing to the lessor.
b. The minimum lease payments under a finance lease of the lessor.
c. Present value of minimum lease payments under a finance lease of the lessor and
any unguaranteed residual value.
d. Present value of minimum lease payments under a finance lease of the lessor.

2. Net investment in the lease is equal to

- a. Gross investment in the lease less unearned finance income

b. Cost of the leased asset
c. The minimum lease payments
d. The minimum lease payments less unguaranteed residual value

3. Lessors shall recognize asset held under a finance lease as a receivable at an amount
equal to

a. Gross investment in the lease

-b. Net investment in the lease
c. Gross rentals
d. Residual value, whether guaranteed or unguaranteed

4. Initial direct costs incurred by the lessor under a sales type lease are

a. Charged to unearned income in the first period of the lease term.

-b. Charged to cost of sales in the first period of the lease term.
c. Deferred and allocated over the lease term in proportion to the recognition of rent
revenue.
d. Deferred and allocated over the lease term on a straight line basis.

5. The cost of sales recognized at the commencement of the lease term by a manufacturer
or dealer lessor is equal to

-a. Carrying amount of the leased asset plus initial direct cost incurred by the lessor
b. Carrying amount of the leased asset minus the guaranteed residual value in absolute
amount
c. Carrying amount f the leased asset minus initial direct cost incurred by the lessor
d. Carrying amount f the leased asset minus the present value of guaranteed residual
value

6. What is the treatment of an unguaranteed residual value in determining the cost of

sales under a sales type lease?

a. The unguaranteed residual value is ignored.

b. The unguaranteed residual value is added to the cost of the leased asset.
 c. The unguaranteed residual value is deducted from the cost of the leased asset at
absolute amount.
-d. The unguaranteed residual value is deducted from the cost of the leased asset at
present value.

7. The sales revenue recognized at the commencement of the lease by a manufacturer or

dealer lessor is

a. Fair value of the asset

b. Present value of the minimum lease payments
-c. Fair value of the asset or present value of the minimum lease payments, whichever
is
lower.
d. Fair value of the asset or present value of the minimum lease payments, whichever
is higher.

8. Which is the correct accounting treatment for a finance lease in the accounts of a
lessor?

a. Treat as a noncurrent asset equal to net investment in the lease. Recognize all
finance payments in income statement.
b. Treat as a receivable equal to gross amount receivable on lease. Recognize finance
payments in cash by reducing debt.
-c. Treat as receivable equal to net investment in the lease. Recognize finance payment
by reducing debt and taking interest to income statement.
d. Treat as receivable equal to net investment in the lease. Recognize finance payments
in cash by reduction of debt.

9. The profit on a finance lease transaction for lessors who are manufacturers or dealers
shall

a. Not be recognized separately from finance income

-b. Be recognized in the normal way on the transaction
c. Only be recognized at the end of the lease term
d. Be allowed on a straight line basis over the lease term

10. Which of the following statements characterizes a sales type lease?

a. The lessor recognizes only interest revenue over the life of the asset.
b. The lessor recognizes only interest revenue over the lease term.
-c. The lessor recognizes a dealer’s profit at lease inception and interest revenue over
the lease term.
d. The lessor recognizes a dealer’s profit at lease inception and interest revenue over
the life of the asset.

ANSWER 41-6
1. a
2. a
3. b
4. b
5. a
6. d
7. c
8. c
9. b
10. c

QUESTION 41-7 Multiple Choice (AICPA Adapted)

1. In accounting for a lease, the account that should appear in the statement of financial
position of a lessor if the direct financing method is used would be

a. Investment in lease property

b. Investment in lease property and estimated residual value
c. Contracts receivable foe equipment rentals and investment in lease property
d. Contracts receivable foe equipment rentals

2. On January 1, 2010, a lessor signed a contract for an eight- year lease of its equipment
with a 10- year life. The present value of the 16 equal semiannual payments in advance
equaled 85% of the equipment’s fair value. The contract had no provision for the lessor to
give up legal ownership of the equipment. Should the lessor recognize rent or interest
revenue in 2011, and should the revenue recognized in 2011 be the same that the revenue
recognized in 2010?

2011 revenue recognized 2011 amount recognized

compared to 2010
a. Rent The same
b. Rent Smaller
c. Interest The same
d. Interest Smaller

3. Under a direct financing lease, the excess of aggregate rentals over the cost of leased
property shall be recognized as income of the lessor

a. In increase amounts during the term of the lease

b. In constant amounts during the term of the lease
c. In decreasing amounts during the term of the lease
d. After the cost of leased property has been fully recovered through rentals

4. The excess of the fair value of leased property at the inception of the lease over its
carrying amount shall be recognized by the dealer lessor as
a. Unearned income from a sales type lease
b. Unearned income from a direct financing lease
c. Manufacturer’s profit from a sales type lease
d. Manufacturer’s profit from a direct financing lease

5. In a lease that is recorded as a sales type lease by the lessor, interest revenue

a. Does not arise

b. Shall be recognized over the period of the lease using the interest method
c. Shall be recognized over the period of the lease using the straight line method
d. Shall be recognized in full as revenue as the inception of the lease

ANSWER 41-7

1. d
2. d
3. c
4. c
5. b