How should a manufacturer account for a sale-type lease?

• A. Take sale profit
• B. Capitalize the IDC
• C. Can't do both
• D. Record as a standard operating lease

Answer: (C)

When a manufacturer launches a sale-type lease, the transaction is treated as a sale of the asset to the lessee with a financing component through the lease payments. At the start, you record a sale of the asset at its fair value and also establish a lease receivable representing the net investment in the lease. The selling profit comes from the difference between the asset’s fair value and its carrying amount, but initial direct costs incurred to originate the lease are not treated as separate profit; instead, those costs are capitalized as part of the net investment in the lease (to be recovered through the lease payments).

Because those initial direct costs are embedded in the net investment, you don’t separately recognize them as profit. In other words, you can’t simultaneously take a selling profit and also capitalize initial direct costs as a separate profit item—the economics of the transaction are captured through the net investment and the pro forma profit at inception. Hence, you can’t do both.