What are the three lease classifications for a lessor?

• A. Operating, financing, and direct financing.
• B. Operating, sales-type, and direct financing.
• C. Service, sales-type, and direct financing.
• D. Operating, capital, and direct financing.

Answer: (B)

In lessor accounting, leases are grouped to show how ownership risk and economics are reflected and how revenue is recognized. There are three classifications: an operating lease, a sales-type lease, and a direct financing lease.

An operating lease keeps the asset on the lessor’s books. Income is recognized as lease payments over the term, and the asset continues to be depreciated by the lessor. There’s no initial profit recorded from the lease itself.

A sales-type lease is treated like a sale with a financing component. At inception, the lessor recognizes revenue equal to the asset’s fair value and, if applicable, a cost of goods sold, creating an initial gross profit. The remaining payments provide interest income over the lease term, typically through a lease receivable.

A direct financing lease also involves a financing component, but there is no initial gross profit. The lessor records a lease receivable for the present value of payments and depreciates the asset, earning interest income over time. The key difference from a sales-type lease is that no profit is taken at inception.

So the three classifications used are operating, sales-type, and direct financing.