Are a sales-type lease and a direct financing lease exactly the same except that at the beginning of the sales-type, you book gross profit as a result of the difference between the carrying value and the PV of future lease payments? After booking the gross profit, everything is the same with both methods, correct? It seems that way to me but I just wanted to be sure.
I am not entirely sure if I understand your questions. But yes, once the inception is correctly accounted for each lease payment is always split into an interest and a principal payment. This is the same as far as I understand.
I believe you are correct Billy
Yes, you are correct, however, all of the examples that I have seen are very confusing because they show the Present Value of the Min Lease Payments as the same amount, but show the Cost = to PV of MLP in a Direct Financing lease and Cost < PV of MLP in a Sales Type lease. As a result, the interest income is exactly the same in each scenario, so it is difficult to see the effect on the income statement after year one. A better example is: DF Lease: PVMLP = $40k; Cost = $40k; Int Rate = 8% Sales Type Lease: PVMLP = $50k; Cost = $40k; Int Rate = 6% Since the interest income (for both lease types) is determined by applying the Int Rate to the Declining Value of the Lease Investment (which is equal to PV of MLP on day one), under a DF lease, you are going to have higher interest income each year. We know that under a Sales Type Lease you get to record Gross Profit in Year one, so in Year one, your Sales Type lease has higher profitability. In each subsequent year, however, the DF lease has higher profitability because you are recording only interest income under both DF and Sales Type and the DF interest income is higher.