CPA Quiz: Sales Type And Direct Financing Leases
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Sales Type And Direct Financing LeasesQuestion 1 of 20

Under ASC 842, which of the following criteria, if met, requires a lessor to classify a lease as a sales-type lease?

The lease term is greater than 50% of the asset's remaining economic life.
The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
The asset is specialized with no alternative use to the lessor.
The present value of lease payments exceeds 75% of the asset's fair value.
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CPA Quiz: Sales Type And Direct Financing Leases

Practice Sales Type And Direct Financing Leases in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

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This quiz focuses on Sales Type And Direct Financing Leases, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

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Question 1

Under ASC 842, which of the following criteria, if met, requires a lessor to classify a lease as a sales-type lease?

  1. The lease term is greater than 50% of the asset's remaining economic life.
  2. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term. (correct answer)
  3. The asset is specialized with no alternative use to the lessor.
  4. The present value of lease payments exceeds 75% of the asset's fair value.
Explanation: Under ASC 842-10-25-2, a lease is a sales-type lease if any one of five criteria is met, including transfer of ownership (Answer B), a purchase option the lessee is reasonably certain to exercise, a lease term covering the major part of the remaining economic life, present value of payments equaling or exceeding substantially all of the fair value, or a specialized asset with no alternative use to the lessor. Transfer of ownership is one of the clearest qualifying criteria. Answer B is correct. Answer A uses 50% for the lease term test - the standard 'major part' threshold is generally interpreted as 75% or more of remaining economic life. Answer C describes the specialized asset/no-alternative-use criterion, which is also one of the five qualifying criteria but is not what is described in Answer B. Answer D applies a 75% threshold to the present value test - the correct threshold under ASC 842 for 'substantially all' is generally interpreted as 90% or more of fair value.

Question 2

A lessor classifies a lease as a sales-type lease on January 1, Year 1. The net investment in the lease is $100,000 and the implicit rate is 6%. Annual lease payments of $23,740 are due at year-end. What is interest income recognized in Year 1?

  1. $23,740
  2. $5,776
  3. $6,000 (correct answer)
  4. $17,740
Explanation: Interest income = Beginning net investment x Implicit rate = $100,000 x 6% = $6,000. Answer C is correct. Answer A uses the full payment as income. Answer B subtracts interest from principal incorrectly. Answer D uses the payment minus interest as income.

Question 3

Under ASC 842, the lessor's 'net investment in the lease' for a sales-type or direct financing lease consists of:

  1. The present value of lease payments not yet received plus the present value of any unguaranteed residual value. (correct answer)
  2. The gross amount of future lease payments only.
  3. The carrying amount of the underlying asset on the lessor's books.
  4. The fair value of the underlying asset at lease commencement.
Explanation: The net investment in the lease is the present value of (1) the lease payments receivable (including guaranteed residual value) and (2) the unguaranteed residual value accruing to the lessor, both discounted at the rate implicit in the lease. Answer A is correct. Answer B uses undiscounted gross payments. Answer C uses the carrying amount, which is relevant for computing selling profit but is not the definition of net investment. Answer D uses fair value at commencement, which may equal net investment but is not the definitional formula.

Question 4

A lessor has a direct financing lease with annual payments of $30,000 for 4 years, beginning January 1, Year 1 (payments at year-end). The implicit rate is 8% and the PV of payments is $99,364. What is the net investment at the beginning of Year 2?

  1. $99,364
  2. $69,364
  3. $107,313
  4. $77,313 (correct answer)
Explanation: Beginning net investment = $99,364. Year 1 interest income = $99,364 x 8% = $7,949. Principal reduction = $30,000 - $7,949 = $22,051. Net investment at beginning of Year 2 = $99,364 - $22,051 = $77,313. Answer D is correct. Answer A is the original investment. Answer B subtracts the full payment without adding interest. Answer C adds interest to the investment without deducting the payment.

Question 5

A lessor enters a direct financing lease on January 1, Year 1. Asset cost: $150,000. Total undiscounted lease payments: $180,000. Unearned interest income at commencement: $30,000. How is the lease receivable presented on the January 1, Year 1 balance sheet?

  1. Lease receivable $180,000 with no contra account.
  2. Net investment $150,000 presented as a single line.
  3. Lease receivable 180,000lessunearnedinterestincome(180,000 less unearned interest income (30,000) = net investment $150,000. (correct answer)
  4. Lease receivable $30,000 representing only unearned income.
Explanation: In a direct financing lease, the lessor records the gross receivable at the total undiscounted payments and offsets unearned interest income as a contra account, yielding a net investment equal to the present value of payments. Answer C is correct. Answer A omits the contra account. Answer B presents only the net amount without the gross receivable disclosure. Answer D records only the unearned income component.

Question 6

Under ASC 842, a lessor recognizes revenue and cost of goods sold at commencement of a sales-type lease when:

  1. The fair value of the underlying asset equals the sum of the present value of lease payments and any unguaranteed residual value. (correct answer)
  2. The lessee has made its first payment under the lease.
  3. The lease term covers more than 75% of the asset's useful life.
  4. The lessor obtains a guarantee of the residual value from a creditworthy third party.
Explanation: At commencement of a sales-type lease, the lessor derecognizes the underlying asset and recognizes revenue (equal to the net investment in the lease, or fair value if lower) and cost of sales (equal to the carrying amount of the asset less PV of unguaranteed residual). The accounting mirrors a sale. The condition is met when commencement criteria are satisfied and the lease is classified as sales-type - not tied to first payment (B), a percentage threshold (C), or a guarantee requirement (D). Answer A describes the recognition framework. Answers B, C, and D are not commencement recognition triggers.

Question 7

Under ASC 842, initial direct costs in a direct financing lease are treated as:

  1. Expensed immediately at commencement.
  2. Added to the cost of goods sold recognized at commencement.
  3. Added to the net investment in the lease and effectively amortized as a yield adjustment over the lease term. (correct answer)
  4. Capitalized separately and amortized on a straight-line basis.
Explanation: In a direct financing lease (where no selling profit is recognized), initial direct costs are added to the net investment in the lease. This reduces the effective yield and results in the costs being amortized into interest income over the lease term. Answer C is correct. Expensing at commencement (A) applies to sales-type leases with a selling profit. Adding to COGS (B) has no basis for direct financing leases. Straight-line amortization as a separate asset (D) is not the ASC 842 treatment.

Question 8

A lessor's sales-type lease: asset carrying amount $95,000, PV of lease payments $112,000, PV of unguaranteed residual value $8,000. What is the cost of sales recognized at commencement?

  1. $112,000
  2. $95,000
  3. $103,000
  4. $87,000 (correct answer)
Explanation: Cost of sales = Carrying amount of asset - PV of unguaranteed residual = $95,000 - $8,000 = $87,000. The lessor retains the economic interest in the unguaranteed residual, so it is excluded from the cost transferred. Answer D is correct. Answer B uses full carrying amount without deducting unguaranteed residual. Answer A uses the lease payment PV. Answer C adds rather than subtracts the unguaranteed residual.

Question 9

A lessor's sales-type lease produces revenue of $110,000 and cost of sales of $85,000 at commencement. What gross profit does the lessor recognize from the lease at inception?

  1. $25,000 (correct answer)
  2. $110,000
  3. $85,000
  4. $195,000
Explanation: Gross profit = Revenue - Cost of sales = $110,000 - $85,000 = $25,000. Answer A is correct. Answer B uses only revenue. Answer C uses only cost of sales. Answer D adds revenue and cost.

Question 10

Under ASC 842, what happens to the unguaranteed residual value in a sales-type lease over the lease term?

  1. It is recognized as revenue in the final year of the lease.
  2. It is depreciated by the lessor over the lease term.
  3. It is deducted from the net investment at commencement and not accreted.
  4. It accretes back to its expected value over the lease term as part of the net investment, recognized as interest income. (correct answer)
Explanation: The unguaranteed residual value is included in the net investment at its present value at commencement. Over the lease term, as the implicit rate is applied to the net investment, the PV of the unguaranteed residual accretes toward its nominal value at the end of the lease. This accretion is captured within interest income. Answer D is correct. Answer A defers recognition to the final year only. Answer B applies depreciation, which is relevant to operating leases. Answer C excludes accretion.

Question 11

On January 1, Year 1, a lessor enters a sales-type lease. The asset's cost is $80,000, its fair value is $95,000, and the present value of lease payments is $95,000. The lease term is 5 years with annual payments of $23,000 due at year-end. What is the selling profit recognized by the lessor at lease commencement?

  1. $15,000 (correct answer)
  2. $95,000
  3. $23,000
  4. $0
Explanation: In a sales-type lease, the lessor recognizes a selling profit equal to the net investment in the lease less the carrying amount of the underlying asset: $95,000 (fair value / PV of lease payments) - $80,000 (cost) = $15,000. Answer A is correct. Answer B records the full lease receivable as profit. Answer C uses one payment amount. Answer D applies to direct financing leases where no profit is recognized at commencement.

Question 12

Under ASC 842, which of the following is required for a lessor to classify a lease as a direct financing lease rather than an operating lease?

  1. The present value of lease payments plus any guaranteed residual value equals substantially all of the fair value of the underlying asset, and collection is probable. (correct answer)
  2. The lease transfers the risks and rewards of ownership to the lessee.
  3. The lessee has a purchase option that it is reasonably certain to exercise.
  4. The underlying asset has no alternative use to the lessor at the end of the lease term.
Explanation: A direct financing lease requires that (1) the PV of payments plus guaranteed residual equals substantially all of the fair value (the 'substantially all' criterion), and (2) it is probable that the lessor will collect the payments. Importantly, the lease must not meet any of the five sales-type criteria. Answer A is correct. Answer B describes the old IAS 17 approach. Answer C would trigger sales-type classification, not direct financing. Answer D (no alternative use) is a sales-type criterion.

Question 13

A sales-type lease has a lease term of 5 years, annual payments of $20,000, an implicit rate of 7%, and an unguaranteed residual value of $10,000 at end of Year 5. The PV of payments at 7% for 5 years is $82,004 and the PV of $10,000 at 7% for 5 years is $7,130. What is the net investment in the lease at commencement?

  1. $100,000
  2. $82,004
  3. $92,004
  4. $89,134 (correct answer)
Explanation: Net investment = PV of lease payments + PV of unguaranteed residual value = $82,004 + $7,130 = 89,134.AnswerDiscorrect.AnswerA(89,134. Answer D is correct. Answer A (100,000) uses the undiscounted total payments only (5 x 20,000),ignoringboththepresentvaluefactorandtheresidualvalue.AnswerB(20,000), ignoring both the present value factor and the residual value. Answer B (82,004) includes only the PV of lease payments and omits the PV of the unguaranteed residual value. Answer C (92,004)addstheundiscountedresidualvalue(92,004) adds the undiscounted residual value (10,000) rather than its present value ($7,130), overstating the net investment.

Question 14

Under ASC 842, a lease that does not meet any of the five sales-type lease criteria but where the present value of lease payments and any guaranteed residual value equals substantially all of the fair value of the underlying asset may qualify as:

  1. An operating lease.
  2. A leveraged lease.
  3. A sales-type lease with a guaranteed residual.
  4. A direct financing lease, if the lease also meets collectibility criteria. (correct answer)
Explanation: Under ASC 842, a direct financing lease arises when the lease does not meet the sales-type criteria but: (1) the PV of lease payments plus any guaranteed residual equals substantially all of the fair value, and (2) it is probable that the lessor will collect the payments plus any residual. Answer D is correct. Answer A (operating lease) applies when no sales-type or direct financing criteria are met. Answer B (leveraged lease) was eliminated under ASC 842. Answer C misapplies the sales-type classification.

Question 15

A lessor has a 4-year sales-type lease. Net investment at the start of Year 3 is $42,000. Implicit rate is 9%. Annual payment is $15,000 at year-end. What is interest income in Year 3?

  1. $15,000
  2. $11,220
  3. $3,780 (correct answer)
  4. $6,000
Explanation: Interest income Year 3 = Beginning net investment x implicit rate = $42,000 x 9% = 3,780.AnswerCiscorrect.AnswerAusesthefullpaymentasincome.AnswerBistheprincipalportion(3,780. Answer C is correct. Answer A uses the full payment as income. Answer B is the principal portion (15,000 - $3,780). Answer D applies an incorrect rate.

Question 16

Machinery Leasing Co. entered into a direct financing lease on July 1, 2024, for equipment with a fair value of $300,000. The lease term is 4 years with annual payments of $85,000 due at the end of each year. The implicit interest rate is 10%. Initial direct costs of $12,000 were incurred by the lessor.

What is the net investment in the lease immediately after the lease commencement?

  1. $269,405
  2. $281,405 (correct answer)
  3. $288,000
  4. $300,000
Explanation: In a direct financing lease, the net investment equals the present value of lease payments plus initial direct costs. PV of payments = $85,000 × 3.16987 (PV ordinary annuity, 4 periods, 10%) = $269,405. Adding initial direct costs: $269,405 + $12,000 = $281,405. Choice A omits the required addition of initial direct costs. Choice C uses an incorrect calculation base. Choice D incorrectly uses the asset's fair value.

Question 17

Regional Equipment Corp has both sales-type and direct financing leases in its portfolio. On December 31, 2024, Regional is preparing year-end financial statements and needs to determine the appropriate classification of lease-related receivables.

For a direct financing lease with quarterly payments where the next four payments will be received within 12 months, how should the net investment be classified on the December 31, 2024 balance sheet?

  1. Entirely as current assets since payments are due within one year
  2. Entirely as non-current assets since it is a long-term lease arrangement
  3. Current portion equal to principal reductions from payments due within one year, remainder as non-current (correct answer)
  4. Current portion equal to total payments due within one year, remainder as non-current
Explanation: The current portion of net investment in leases should include only the principal portion of payments to be received within one year, not the interest portion. This follows the same principle as other long-term receivables where only principal reductions are classified as current. Choice A incorrectly classifies the entire investment as current. Choice B incorrectly ignores the current portion. Choice D incorrectly includes interest portions in current assets.

Question 18

Precision Tools Corp entered into a lease agreement classified as a direct financing lease on June 1, 2024. The lease term is 5 years with semiannual payments of $25,000 due at the end of each 6-month period. The implicit annual rate is 12% (6% semiannually). Initial direct costs were $18,000. The lease includes a purchase option that is reasonably certain to be exercised for $10,000 at the end of the lease term.

What is the effective semiannual interest rate that should be used to recognize interest income over the lease term?

  1. 6.00%
  2. 6.85% (correct answer)
  3. 7.20%
  4. 7.50%
Explanation: When initial direct costs are incurred in a direct financing lease, the effective interest rate must be recalculated to include these costs in the investment base. The total investment equals the present value of lease payments ($25,000 × 8.53020 = 213,255)plusthepresentvalueofthepurchaseoption(213,255) plus the present value of the purchase option (10,000 × 0.55839 = 5,584)plusinitialdirectcosts(5,584) plus initial direct costs (18,000), totaling $236,839. The effective semiannual rate that equates this investment to the contractual cash flows is approximately 6.85%. Choice A ignores the impact of initial direct costs on the effective rate.

Question 19

Global Equipment Inc. entered into two lease agreements on January 1, 2024. Lease A qualifies as a sales-type lease with fair value of $400,000, carrying amount of $320,000, and present value of lease payments of $380,000. Lease B qualifies as a direct financing lease with fair value of $250,000, initial direct costs of $15,000, and present value of lease payments of $250,000.

What is the combined gross profit that Global Equipment should recognize from both leases on January 1, 2024?

  1. $45,000
  2. $60,000 (correct answer)
  3. $80,000
  4. $95,000
Explanation: Sales-type lease (A): Gross profit = Sales revenue - Cost of goods sold. Sales revenue is the lower of fair value (400,000)orPVofleasepayments(400,000) or PV of lease payments (380,000) = $380,000. COGS = $320,000. Gross profit = $380,000 - $320,000 = $60,000. Direct financing lease (B): No gross profit is recognized at commencement; profit is recognized over the lease term as interest income. Total gross profit = $60,000. Choice A incorrectly reduces profit by initial direct costs. Choice C uses fair value instead of PV for Lease A. Choice D incorrectly includes profit from both leases.

Question 20

Tech Solutions Inc. leased computer servers to DataCorp under a 3-year agreement beginning January 1, 2024. Annual lease payments of $75,000 are due at the beginning of each year. The servers have a fair value of $200,000, estimated useful life of 5 years, and carrying amount of $150,000. The implicit rate is 12%. The lease transfers ownership at the end of the term, and Tech Solutions incurred $8,000 in initial direct costs.

What journal entry should Tech Solutions record on January 1, 2024, to recognize the cost of goods sold?

  1. Dr. Cost of Goods Sold $150,000; Cr. Equipment $150,000 (correct answer)
  2. Dr. Cost of Goods Sold $158,000; Cr. Equipment $150,000; Cr. Cash $8,000
  3. Dr. Cost of Goods Sold $158,000; Cr. Equipment $158,000
  4. Dr. Cost of Goods Sold $142,000; Cr. Equipment $150,000; Dr. Initial Direct Costs $8,000
Explanation: In a sales-type lease, cost of goods sold equals the carrying amount of the leased asset ($150,000). Initial direct costs are expensed separately in sales-type leases, not included in COGS. The entry removes the asset at its carrying amount. Choice B incorrectly includes initial direct costs in COGS. Choice C treats initial direct costs as part of asset cost. Choice D incorrectly reduces COGS and capitalizes initial direct costs.