Technical Spotlight: Accounting for Leases (Lessors)

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(Posted February 2025)

Accounting for leases tends to be a commonly tested topic on the CPA Common Final Examination (CFE). The treatment is very different depending on both the role – whether you are the lessor or the lessee – and also the framework – whether reporting under ASPE or IFRS® Standards.

This blog focuses on the key technical considerations relating to the accounting treatment for lessors under both ASPE and IFRS Standards. The lessor is the party that owns the asset and rents it to a customer (lessee). For more information on lease accounting for lessees, see last week’s blog.

ASPE
Relevant Technical

The accounting for leases from the lessor’s perspective is governed by ASPE 3065, Leases. A lease can be classified as a direct financing lease, a sales-type lease, or an operating lease. The lessor must account for the lease as an operating lease unless each of the following conditions are present:

  • One of the following three criteria are met:
  • Reasonable assurance exists that ownership of the asset will transfer to the lessee by the end of the lease term, either by a transfer of title at the end of the lease term or the existence of a bargain purchase option. A bargain purchase option is defined as any option to purchase the asset at the end of the lease at a price that is below the expected market value at the end of the lease.
  • The lease term is of such a duration that the lessee will receive substantially all of the economic benefits that are expected to be derived from the use of the leased property over its life. Some analysis may be required to determine the proper lease term to use. For example, if a bargain renewal option exists (e.g., a renewal at below market rates at the time of renewal, which could be a renewal at the same rate as the initial term), this should be included in the total lease term used in the assessment. The guideline for “substantially all” is 75% of the asset’s useful life.
  • The present value of the minimum lease payments represents substantially all of the fair value of the asset. Ensure that you compare the present value of minimum payments to the fair value of the leased asset now (at lease inception), rather than its expected future fair value (if provided in the case). If a residual value (the fair market value of the asset at the end of the lease term) is provided in the case, this should only be included in the present value calculation if there is a bargain purchase option or transfer of title expected at the end of the lease term (e.g., the amount is guaranteed). Incorrectly including (or excluding) this amount can have a major impact on the present value amount derived, which can result in an inappropriate conclusion on the lease treatment. The guideline for “substantially all” is 90% or more of the asset’s fair value.
  • Credit risk associated with the lease is normal when compared to the risk of collection of similar receivables.
  • Any non-reimbursable costs that the lessor is likely to incur under the lease can be reasonably estimated.

The percentage guidelines noted above are not definitive requirements. Judgment should be exercised in determining their application (e.g., an amount just below 90% may be considered “substantially all” for the PV criteria).

The “credit risk” and “non-reimbursable” criterion are only relevant if one of the first three criteria are met, so the lease is considered a capital lease.

Initial Treatment

If the above conditions are not met, the lessor accounts for the transaction as an operating lease. This requires that the asset’s carrying value remain on the lessor’s books and lease revenue is recognized into income over the term of the lease as it becomes due.

If the above conditions are met, the lease is considered to have transferred substantially all of the risks and benefits of ownership to the lessee, and accordingly, the lessor must account for the lease as either a direct financing lease or a sales-type lease.

  • A direct financing lease exists when the fair value of the leased asset is the same as the lessor’s carrying amount at the lease commencement date.
  • A sales-type lease exists when the fair value of the leased asset is greater or less than its carrying amount, resulting in a profit or loss to the lessor at lease inception.
Direct Financing Lease

The lessor must record a net investment in the lease (receivable) equal to the minimum lease payments plus any unguaranteed residual value and derecognize the asset on its books. Deferred financing income must also be recognized. Any initial direct costs are expensed when incurred.

Sales-type Lease

The lessor must record a net investment in the lease (receivable) equal to the minimum lease payments plus any unguaranteed residual value. Deferred financing income must also be recognized, along with sales revenue and cost of goods sold relating to the sale of the asset. Any initial direct costs are expensed at the inception of the lease.

How to Write on the CFE

While you must adapt to the issue and case facts presented to you, there is an approach that can often be taken to develop sufficient depth in your analysis.

Step 1: Use case facts to assess the type of lease

Analyze each of the criteria explained above using case facts to determine if each of the relevant conditions are met. For the “economic life” (second) and “PV” (third) criterion, ensure you calculate the percentages and explicitly compare them to the respective guidelines (i.e., 75% and 90%, respectively) to support your conclusions. Conclude definitively as to whether the lease is to be considered a direct financing lease, sales-type lease, or operating lease based on the criteria as well as the nature of the situation, consistent with your analysis.

Step 2: Assess the financial reporting implications

Using your conclusion from Step 1, explain the financial statement impact (e.g., how to record the net investment in the lease, if it is a direct financing or sales-type lease situation). Be sure to quantify the amounts to record.

Ensure consistency in the inputs used for the present value calculation. For example, if a monthly rate is used in the formula, ensure that both the period and payment used are in monthly terms as well (not annual). This is a common error made by candidates, whereby one or more of the inputs is not consistent with others, which materially impacts the calculation. You may also need to integrate your results into a summary calculation, such as revised financial statements, a materiality calculation, or financial ratios.

IFRS
Relevant Technical

The accounting for leases from the lessor’s perspective is governed by IFRS 16, Leases, and is much different than the application of ASPE 3065 explained above. Under IFRS 16, the lease can be a finance lease or an operating lease. The lessor must account for the lease as an operating lease unless one of the following finance lease criteria are met:

  • The lease transfers ownership of the asset to the lessee by the end of the lease term.
  • A bargain purchase option exists and is reasonably certain to be exercised by the lessee at the date of lease commencement.
  • The lease term is for the major part of the economic life of the asset. Some analysis may be required to determine the proper lease term to use. For example, if an option to extend the lease is provided and it is reasonably certain that the lessee will exercise it (e.g., it is a bargain compared to fair value), this should be included in the total lease term used in the assessment.
  • The present value of the lease payments amounts to at least substantially all of the fair value of the asset. Future value should only be included the present value calculation if a bargain purchase option is reasonably expected to be paid by the lessee or if there is a guaranteed residual value. If the residual value is not guaranteed, exclude this from the calculation. Incorrectly including (or excluding) this amount can have a major impact on the present value amount derived, which can result in an inappropriate conclusion on the lease treatment.
  • The asset is of a specialized nature and can only be used by the lessee without major modifications.


For the “economic life” and “PV” criterion, unlike ASPE, there is no quantitative guidance (e.g., 75% or 90%, respectively) provided under IFRS 16 to assess whether each criterion is met, and professional judgment must be used.

Initial Treatment

If one of the criteria noted above is met, a finance lease exists. A determination then needs to be made as to whether the lessor is a manufacturer or dealer, to assess the proper treatment.

If the lessor is not a manufacturer or dealer, the lessor must record a lease receivable (net investment in the lease) that is comprised of the total lease payments receivable by the lessor plus any unguaranteed residual value, discounted using the interest rate implicit in the lease. Any initial direct costs are also included in the net investment in the lease, rather than expensed. The underlying asset is also derecognized with the difference between its fair value and carrying amount recognized into income as a gain or loss on the asset’s disposal.

If the lessor is a manufacturer or dealer, in addition to the lease receivable created, the lessor must record both revenue earned and cost of goods sold incurred for the sale of the asset. The determination of these values depends on whether a bargain purchase option exists, as well as whether the residual value is guaranteed or not.

If none of the criteria noted above are met, an operating lease exists. In this situation, the lease payments are recognized into income on a straight-line basis over the term of the lease.

It is important to note that some additional secondary indicators exist that should be considered when assessing the lease classification from the lessor’s perspective. If none of the five criteria noted above have been met, the lease may still be considered a finance lease based on the following factors, when assessed either individually or in aggregate:

  • The lessee is permitted to cancel the lease and must bear the costs of any losses incurred by the lessor.
  • Any gains or losses arising from the fluctuation in fair value of the residual accrue to the lessee.
  • The lessee is permitted to use the lease for a secondary period at a rent that is substantially lower than market rent.
Subsequent Treatment

If a finance lease exists, lease payments made reduce the net investment in the lease (receivable). Further, interest income is recognized on an annual basis using the rate implicit in the lease, which impacts the net investment in the lease as well. The interest income calculation differs depending on whether payments are due at the beginning or end of the year.  This applies regardless of whether the lessor is considered a manufacturer or dealer or not. 

How to Write on the CFE

While you must adapt to the issue and case facts presented to you, there is a common approach that can often be taken to develop sufficient depth in your analysis.

Step 1: Use case facts to assess whether a lease exists

Analyze each of the criteria explained above using case facts in order to determine if a finance lease exists. If one does exist, consider whether the lessor is a manufacturer/dealer or not and conclude accordingly.

Step 2: Assess the financial reporting implications

Using your conclusion from Step 1, explain the financial statement impact both for the initial treatment and subsequent treatment. Be sure to quantify the amounts to record (ensuring consistency in your inputs as discussed above), considering both the initial and subsequent treatment.