How do sales-type leases differ from direct financing leases?

Sales-type leases and direct financing leases are distinguished primarily by how control of the leased asset is treated and the economic outcomes for the lessor. In a sales-type lease, the lessee gains control of the asset, meaning they have the ability to use the asset as if they own it, and this typically involves recognizing the leased asset and corresponding liabilities on their balance sheet. The lessor, on the other hand, recognizes a profit at the inception due to the difference between the fair value of the asset and its book value, which establishes the nature of a sales-type lease.

In contrast, a direct financing lease does not result in the lessor recognizing upfront profit or loss related to the leased asset. The lessor's return is based on the interest income from the lease payments over time rather than an initial profit from the transfer of the asset. Therefore, in a direct financing lease, the lessee uses the asset without the lessor recognizing a gain at the start of the lease.

This distinction highlights the different motivations and accounting treatments associated with each type of lease arrangement. By understanding that the lessee gains control in sales-type leases and the lessor's treatment of profits, the concept of control and its implications for financial reporting becomes clearer.