# Sales Type Lease

Assuming all other factors are constant, a sales-type lease will result in higher: A) interest revenue as compared to a direct financing lease. B) cash flow from investing (CFI) as compared to a direct financing lease. C) cash flow from operations (CFO) as compared to a direct financing lease. D) total cash flows. Your answer: C was incorrect. The correct answer was B) cash flow from investing (CFI) as compared to a direct financing lease. The sales-type lease has higher CFI (collection of lease receivable is considered a CFI) and lower CFO (interest revenue is considered a CFO) as compared to a direct financing lease. This results from the difference in the implicit rate among the two lease types. -------------------------------------------------------------------------------- Wise forum contributors - Isn’t the gain recorded at inception in CFO?

anyone?

This sounds like it’s from the perspective of the lessor, not the lessee

that too not in early years.

Why cant interest expense be higher considering the fact that Gross porfit is considered in sales type lease

An example may be helpful. Assume you receive two offers: you may buy a car for \$80,000 outright, or you can enter into a lease with five annual payments of \$20,000. The car costs the seller \$50,000. In a sales-type lease, the implicit rate of interest is 7.93%. That’s because five annual payments of \$20,000, discounted at 7.93%, equals the selling price of \$80,000. In a direct-financing lease, the implicit rate of interest is 28.65%. That’s because five annual payments of \$20,000, discounted at 28.65%, equals the cost of \$50,000. Let’s look at Cash Flow from Investing if this were a sales-type lease (assume you buy from a dealer). At inception, we log a profit of 30,000, which is a CFO inflow and a CFI outflow. In year one, interest revenue is equal to (80,000) x 7.93% = \$6,344, which is a CFO inflow, leaving \$13,656 as principal repayment, which is a CFI inflow. Over the life of the lease, \$20,000 of interest is recognized as CFO inflow and \$80,000 of principal repayment is recognized as CFI inflow (you can see this on an amortization table). Now let’s consider Cash Flow from Investing if this were a direct financing-type lease (assume you buy from an accounting firm). At inception, we log no profit. In year one, interest revenue is equal to (\$50,000) x 28.65% = \$14,325, which is a CFO inflow, leaving \$5,675 as principal repayment, which is logged as a CFI inflow. Over the life of the lease, \$50,000 of interest is recognized as CFO inflow and \$50,000 of principal repayment is recognized as CFI inflow. In sum, over the life of a sales-type lease (excluding first year), \$20,000 is recognized as CFO inflow and \$80,000 is recognized as CFI inflow, while over the life of a direct financing lease (excluding first year), \$50,000 is recognized as CFO inflow and \$50,000 is recognized as CFI inflow. Under a direct financing lease, all the profit is baked into interest (and thus CFO) – and this makes sense since someone in the financing business profits from interest. Under a sales-type lease, the profit is recognized up front, essentially as if the dealer sold the item directly to book a profit, then extended the buyer a loan to cover the price. However, if we add the profit recognized in year 1 under a sales-type lease to CFO and subtract it from CFI, as required, the net CFO and CFI are each \$50,000 across the lifetime of the lease under both methods. I think the question could have been more clear that it was looking for the effect over the life of the lease rather than year 1.

Thanks a lot for the explanation . Really appreciate it. Yes the question does not seem very clear

perfect chebychev ur god man/woman!