Question 9.22: Financial Statement Impact of a Sales-Type Lease for the Les......
Financial Statement Impact of a Sales-Type Lease for the Lessor
Assume a (hypothetical) company, Selnow Inc., owns a piece of machinery and enters into an agreement to lease the machinery on 1 January Year 1. In the lease contract, the company requires four annual payments of €28,679 starting on 1 January Year 1. The present value of the lease payments (using a 10 percent discount rate) is €100,000, and the fair value of the equipment is €90,000. The useful life of the machinery is four years and its salvage value is zero.
1. Is the lease a direct financing or sales-type lease?
2. What is Selnow’s income related to the lease in Year 1? In Year 2? Ignore taxes.
to 1: This is a sales-type lease: The present value of lease payments is more than the lessor’s carrying amount of the leased asset. The difference between the present value of the lease payments and the carrying amount of the leased asset is the lessor’s profit from selling the machinery. The lessor will record a profit of €10,000 on the sale of the leased equipment in Year 1 (€100,000 present value of lease payments receivable less €90,000 value of leased equipment).
to 2: In Year 1, Selnow shows income of €17,132 related to the lease. One part of this is the €10,000 gain on the sale of the lease equipment (sales revenues of €100,000 less costs of goods sold of €90,000). Selnow also shows interest revenue of €7,132 on its financing of the lease (lease receivable of €71,321 after the initial lease payment is received times the 10 percent discount rate). In Year 2, Selnow reports only the interest revenue of €4,977 (lease receivable of €49,774 after the 1 January lease payment is received times the 10 percent discount rate). The table following shows lease payments received, interest revenue, and reduction of the lease receivable for Selnow’s sales-type lease. Note that this table is the same as DIRFIN’s table in the previous example with the direct financing lease. They are the same because the present value of the lease payments in both cases is the same. It is the fair value of the equipment that differs between the two examples.
| Year | Lease Receivable, 1 January (a) | Annual Lease Payment Received, 1 January (b) | Interest (at 10%; accrued in previous year) (c) | Reduction of Lease Receivable, 1 January (d) | Lease Receivable on 31 December after Lease Payment on 1 January of Same year (e) |
| 1 | € 100,000 | € 28,679 | € 0 | € 28,679 | € 71,321 |
| 2 | 71,321 | 28,679 | 7,132 | 21,547 | 49,774 |
| 3 | 49,774 | 28,679 | 4,977 | 23,702 | 26,072 |
| 4 | 26,072 | 28,679 | 2,607 | 26,072 | 0 |
| € 114,717 | € 14,717 | € 100,000 |