How does a lessor account for a sales-type lease with a worked calculation?

A sales-type lease occurs when the lessor effectively sells the underlying asset to the lessee through the lease. The lessor recognizes two types of income: a selling profit or loss at lease commencement and interest income over the lease term.

When is a lease classified as sales-type for the lessor?

If any one of these criteria is met (under ASC 842 / similar under IFRS 16):

1. Transfer of ownership at lease end
2. Bargain purchase option
3. Lease term is a major part (>= 75%) of the asset's economic life
4. Present value of lease payments >= substantially all (>= 90%) of the asset's fair value
5. The asset is so specialized only the lessee can use it

Comprehensive Worked Example:

Mapleton Leasing (lessor) leases equipment to Brightwater Manufacturing:

• Fair value of equipment: $500,000
• Lessor's cost (carrying amount): $380,000
• Lease term: 5 years
• Annual lease payment: $115,000 (paid at end of each year)
• Interest rate implicit in the lease: 6%
• No residual value, no purchase option
• PV of annuity factor (5 years, 6%): 4.2124

Step 1 — Calculate the lease receivable:

Lease receivable = PV of lease payments = $115,000 x 4.2124 = $484,426

Since the fair value is $500,000 and PV of payments is $484,426, assume no selling profit adjustment for simplicity (or the difference may be a residual value). Let me use the lease receivable at $484,426.

Step 2 — At commencement, record the "sale":

Selling profit = $484,426 - $380,000 = $104,426 (recognized at inception)

Step 3 — Lease receivable amortization (interest income):

Total interest income over 5 years = $90,574

Income statement impact by year:

Key points for the exam:

1. The selling profit is front-loaded — recognized at commencement
2. Interest income declines over time as the receivable amortizes
3. The lease receivable replaces the physical asset on the balance sheet
4. Revenue recognition creates a cost of goods sold entry matching the asset's carrying value

Exam tip: CFA Level II frequently tests the initial journal entries and asks for Year 1 or Year 2 interest income. Set up the amortization table and the answers fall out directly.

For more lease accounting practice, visit our CFA Level II question bank.