Lessors and Sales-Type Capital Leases

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When a lessor enters a sales-type capital lease, several journal entries will be made to account for the transaction:

  • An investment in lease asset is created on the balance sheet (NOTE: this value is greater than the reduction to inventory, so the lessorā€™s assets on the balance sheet have grown as a result of the transaction).
  • A cost of goods sold expense is calculated and recognized (NOTE: COGS is netted against sales revenue to determine gross profit or loss on the ā€œsaleā€).
  • Sales revenue is recognized.
  • The inventory asset account on the balance sheet is reduced.

Cash Flows for Lessorā€™s with Sales-Type Capital Leases

NOTE: Local accounting regulations may vary in treatment of these cash flows for a sales-type capital lease.

  • Over the term of the lease, most of the lesseeā€™s payment is applied to reducing the investment in lease asset (as the lessee is fulfilling its financial obligation to repay principal).Ā  The remaining portion of the lesseeā€™s payment is treated as interest income by the lessor.
  • At lease signature, it is quite possible that no cash flows occur, however with the sales-type method, the lessor shows the investment in the lease as an investing cash outflow and the gross profit on the sale as an operating cash inflow.
  • As the lessee pays the lessor during the lease term, the interest income portion of the payment may be treated as an operating cash inflow and the principal pay-down portion of the lesseeā€™s payment may be treated as an investing cash inflow.