Definition
A sales-type lease is a type of lease arrangement from the perspective of the lessor, wherein one or more of the criteria required for categorizing a lease as a capital lease are met. Additionally, the arrangement must satisfy two critical criteria:
- Collectibility of the minimum lease payments is “reasonably predictable”.
- There are no “important uncertainties” regarding the amount of unreimbursable costs yet to be incurred by the lessor.
A sales-type lease usually involves the transfer of ownership risk and benefits of the leased asset to the lessee before the lease term ends.
Examples
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Leasing of Heavy Machinery: A manufacturer leases a piece of heavy machinery to a construction company for 5 years. The lease agreement stipulates that the construction company will take full ownership at the end of the lease term for a nominal fee. The collectibility of the lease payments is predictable, and the manufacturer (lessor) does not anticipate significant unreimbursable costs.
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Office Equipment Leasing: A vendor leases office equipment to a company with a 3-year lease period. The terms include a bargain purchase option, fulfilling the capital lease criteria. The vendor performs a credit check to ensure payment collectibility and anticipates no major uncertainties regarding future costs.
Frequently Asked Questions (FAQs)
Q1: What distinguishes a sales-type lease from an operating lease?
A1: In a sales-type lease, the lessor typically recognizes a profit or loss on the sales transaction at the lease’s inception, reflecting the immediate sale of the asset. In contrast, an operating lease does not involve the transfer of ownership benefits or risks of the asset, and the lessor recognizes lease income over time rather than upfront.
Q2: What are the key accounting entries for a lessor in a sales-type lease?
A2: The key accounting entries involve:
- Recording the lease receivable at the present value of future payments.
- Recognizing the cost of goods sold and the removal of the leased asset from the balance sheet.
- Recognizing revenue equivalent to the fair value of the leased asset.
Q3: When should a lessor reassess the collectibility of lease payments?
A3: A lessor should reassess the collectibility of lease payments when there are changes in circumstances or new information indicating that the collectibility assumptions have shifted.
Related Terms
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Capital Lease: A lease that transfers substantially all risks and benefits of ownership of the asset to the lessee, typically recorded as an asset and liability in the lessee’s books.
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Operating Lease: A lease that does not transfer significant ownership risks and benefits; lease payments are typically recognized as expenses over the lease term.
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Lease Receivable: The present value of future lease payments that is recorded as a receivable by the lessor in a sales-type or direct financing lease.
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Bargain Purchase Option: An option provided to the lessee to purchase the leased asset at a price significantly lower than its expected fair value at the date the option becomes exercisable.
Online References
Suggested Books for Further Studies
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
- Financial Statement Analysis and Valuation by Peter D. Easton, Mary Lea McAnally, Gregory A. Sommers, Xiao-Jun Zhang
- Creating and Implementing Effective Leasing Programs by Robert S. Guminski
- Leases: Preparation, Negotiation, and Administration by A.S. Kuricheva
Fundamentals of Sales-Type Lease: Accounting Basics Quiz
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