How should a lessor account for a direct finance lease?

• A. Net investment (book value) in the lease is recorded as an asset on the balance sheet; plus Gross Investment minus Unearned Income equals Net Investment
• B. The lease payments are recognized as revenue when received
• C. The leased asset remains on the balance sheet as an asset and no lease receivable
• D. The entire lease is treated as financing with no revenue until end

Answer: (A)

In a direct finance lease, the lessor treats the lease like a financing arrangement and replaces the leased asset on the balance sheet with a net investment in the lease. The net investment is the present value of the expected cash flows from the lease and is obtained by taking the gross investment (the sum of the minimum lease payments plus any unguaranteed residual value) and subtracting unearned income. This net investment is the asset the lessor carries, while interest revenue is recognized over time as the net investment is amortized, using the appropriate interest method. Lease payments are not recorded as revenue all at once; they are split into interest income and a reduction of the net investment, reflecting the financing nature of the arrangement. The other options don’t fit because they either keep the asset on the books without a corresponding lease receivable, recognize revenue only when payments are received, or defer all revenue to the end of the lease term.