Lessors and Direct Financing Capital Leases

This lesson is part 23 of 26 in the course Financial Reporting Part 1

When a financing firm enters into a direct financing capital lease, the lessor reduces PPE shown on its balance sheet and creates an investment in lease asset; the total value of assets on the lessor’s balance sheet is unchanged.

NOTE: Local accounting regulations may vary in treatment of these cash flows for a direct financing capital lease.

Over the life of the direct financing capital lease, the lessor receives a payment from the lessee. A portion of the payment is classified as interest income on the income statement and the remaining portion of the payment is used to reduce the investment in lease asset on the balance sheet.
Unlike the cash flows described in the sales-type lease above, the statement of cash flows are not impacted at the time the lease is entered for a direct financing lease.
When the regular payments are made by the lessee towards the direct finance lease, the lessor reports the interest income as an operating cash flow and the investment in lease asset pay down as an investing cash inflow.