In what situation will a lessor classify a lease as a direct financing lease?

A lessor classifies a lease as a direct financing lease when specific collection criteria are met. This classification is primarily based on the lessor's expectations of collecting the lease payments from the lessee, rather than the characteristics of the lease itself, like the payment structure or lease term.

For a lease to be classified as a direct financing lease, the lessor must reasonably expect to collect not only the lease payments over the term of the lease but also any related costs to the extent that those costs are recoverable. This means that the lessor should be assured that the lessee is financially capable of making those payments.

If the collection criteria are not met, the lessor could classify the lease differently, potentially as an operating lease. The "OWNES" criteria, which relate to determining if a lease qualifies as a sales-type lease for the lessor (ownership transfers, lessee has option to purchase, net present value of payments equals or exceeds fair value, etc.), are not applicable when assessing a direct financing lease.

The duration of the lease also does not, in itself, determine the classification; rather, it is the ability of the lessor to collect the payments that is critical. Thus, the specific collection criteria relevant to a direct financing