I was re-reading Schweser page 256 and had a bit of trouble with one paragraph: “Compared to a sales type lease, a direct financing lease will result in lower net income, lower retained earnings, and lower equity by the amount of profit on sale that is recorded for a sales type lease.” I can understand how this would be correct if this pertained to the first period. The way I have thought about it is that a sales type lease reports the profit on the equipment right away and then recognizes interest income as it comes in. With the direct financing lease, all of the income that comes in is the profit. I thought that the total net income over all lease periods was the same for both types, the only difference being that a sales type lease recognizes the profit first and less interest income per year in the successive years of the lease. The direct financing lease doesn’t recognize a profit up front, but recognizes much more interest income per year since the rate is determined using the cost of the equipment. Am I wrong here? Also, for all of you that are going over this again, I found an old post that is extremely useful. http://www.analystforum.com/phorums/read.php?11,636431,636730#msg-636730
A lease is clasified as sales-type lease it it meets one or more of the 4 capital lease criteria and both sales-type and direct financing lease criteria (no outstandng obligations of the lessor and certainty of lease payments), and give manufacturer’s or dealer’s profit (or loss) to the lessor (the fair value of the asset is not equal with the book value of the asset for the lessor). A lease is clasified as direct financing lease if it meets one or more of the capital lease criteria, and both sales-type and direct financing lease criteria but do not give manufacturer’s or dealer’s profit (or loss) to the lessor (the fair value of the asset is equal with the book value of the asset for the lessor).
Thanks map1, but I was more interested in clearing up the matter described in the original post
vbcfa Wrote: ------------------------------------------------------- > I can understand how this would be correct if this > pertained to the first period. > Your statement would be correct is the company opened, existed for one period and the went out of business. Bu perhaps think of it this way, since we assume the company’s are a going concern (i.e. exist indefinitely-ish) then the continued process of a sales type leases will continue to report profits and ealier then the direct financing lease structure… kind of like “stuffing the channel” for revenue recognition.
so i guess over the long run, profits are the same but the sales type lease reports them sooner?