Question

Explain the distinction between a direct-financing lease and a sales-type lease for a lessor.

Answer 1

A sales type lease, also sometimes known as a capital lease, derives its name from its similarity to a sale. These types of leases apply in situations such as a manufacturer leasing property or the use of property, to a lessee. This could be equipment, vehicles or other goods. Because the lessee receives the use of property in exchange for payments and assumes the liability for the asset, the lease resembles the purchase of an item. However, unlike purchase situations, the lessor expects the lessee to return the equipment or provide payment for its purchase upon the expiration of the lease.

A direct financing lease bears similarity to a sales type lease in that the lessor provides property while the lessee provides regular payments in exchange for the use of that property. The primary difference between these lease types revolves around the value of the lease in relation to the property. In a sales type lease, the lessor records a profit or loss on a property based on the amount of payments received compared to the value of property when leased vs. when returned. When a lessor leases property under a sale type lease, for instance, the lessor hopes to earn profit on the property in addition to any money earned on interest. In a direct financing lease, the lessor only earns a profit on interest, charging payment amounts that directly equate to the value of the property in question.