Lessor classification
Apply the same five criteria used by lessees (ownership transfer, purchase option reasonably certain, major part of remaining economic life, PV of payments ≈ substantially all fair value, specialized asset with no alternative use):
| If… | Classification |
|---|---|
| Any of the five criteria is met | Sales-type lease |
| None met, but PV of payments + residual value guaranteed by a third party ≈ substantially all fair value and collection is probable | Direct financing lease |
| Neither of the above | Operating lease |
Accounting by type
| Type | At commencement | Over the term |
|---|---|---|
| Sales-type | Derecognize the asset; recognize a net investment in the lease and selling profit immediately | Interest income using the effective interest method |
| Direct financing | Derecognize the asset; recognize net investment. Selling profit is deferred and recognized over the term | Interest income |
| Operating | Keep the asset on the books | Straight-line lease income; continue depreciating the asset |
IMPORTANT — the key difference: A sales-type lease recognizes selling profit up front; a direct financing lease defers it over the lease term. Both put a net investment in the lease on the lessor's balance sheet in place of the asset.
Net investment in the lease
Net investment = present value of lease payments + present value of the unguaranteed residual value, discounted at the rate implicit in the lease.
Sale-leaseback
A sale-leaseback qualifies as a sale only if the transfer meets the ASC 606 criteria for a sale (control transfers). If it does, the seller-lessee recognizes the gain or loss and accounts for the leaseback as a normal lease. If control does not transfer, the entire transaction is a financing arrangement — no sale, no gain, and the "proceeds" are recorded as debt.
EXAM TIP: A repurchase option held by the seller-lessee almost always prevents sale treatment, because control never really transferred.