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Manufacturer or Dealer Lessors Explained - IFRS 16

8/20/2025
IFRS 16
Table of Contents

What is a Manufacturer or Dealer Lessor?

A manufacturer or dealer lessor is an entity that sells assets in the normal course of business and also offers those assets under lease arrangements. Unlike banks or other financial lessors who primarily earn interest income, manufacturer or dealer lessors generate profit from both the sale of the asset and the financing element of the lease.

A common example is a car manufacturer that leases vehicles to customers through its dealership network. Here, the lease contract is not just a financing arrangement, but also part of the sale of the car itself.

How Should a Manufacturer or Dealer Lessor Account for Leases?

When a manufacturer or dealer lessor enters into a finance lease, the accounting reflects both the sale of the asset and the financing provided to the customer. This involves recognising revenue, cost of sale, and selling profit or loss immediately at the commencement of the lease:

  • Revenue
    Revenue should be equal to the fair value of the underlying asset, or, if lower, the present value of the lease payments accruing to the lessor, discounted using a market rate of interest. The present value of lease payments (also referred to as the lease receivable under ASC 842) is equal to the net investment in the lease less the present value of the unguaranteed residual value.

  • Cost of Sale
    Cost of sale is the cost, or carrying amount if different, of the underlying asset less the present value of the unguaranteed residual value.

  • Selling Profit or Loss
    Selling profit or loss is the difference between revenue and the cost of sale, in accordance with the entity’s policy for outright sales to which IFRS 15 applies. A manufacturer or dealer lessor shall recognise selling profit or loss on a finance lease at the commencement date, regardless of whether the lessor transfers the underlying asset as described in IFRS 15.

The key point is that the profit element is recognised upfront, rather than being spread over the lease term. This distinguishes manufacturer or dealer lessors from other types of lessors.

For operating leases, however, the approach is different: no selling profit is recognised at the outset, because an operating lease is not equivalent to a sale. Instead, lease income is spread over the lease term.

Restriction on Discount Rate

Manufacturer or dealer lessors sometimes quote artificially low interest rates to attract customers. IFRS 16 requires that in such cases, the lessor restricts selling profit to the amount that would have arisen had a market rate of interest been used. This prevents excessive upfront recognition of income.

In practice, manufacturer or dealer lessors are therefore advised to use the higher of the interest rate implicit in the lease and a market rate of interest as the discount rate for the net investment in the lease.

Costs Incurred in Obtaining a Finance Lease

Unlike other lessors, manufacturer or dealer lessors must expense costs incurred in obtaining a finance lease immediately. This is because such costs are considered related to earning the selling profit, not to the financing activity. Therefore, they do not form part of the net investment in the lease and are excluded from the definition of initial direct costs.

Journal Entries – Example

Scenario

  • Market rate = 4%
  • Payments = 200,000 payable annually in arrears
  • Lease term = 3 years
  • Cost spent to obtain the lease = 20,000
  • Carrying amount of the underlying asset = 550,000
  • Unguaranteed residual value = 10,000
  • Fair value of the asset = 575,000

Result

  • Implicit interest rate: PV = -575,000; PMT = 200,000; N = 3; I = 2.16%
  • Lower than market, therefore use market rate of 4%
  • Present value of unguaranteed residual value at 4% discounted over 3 years = 8,890
  • Lease receivable = payments of 200,000 discounted over 3 years at 4% = 555,018
Dr Net investment in the lease      563,908  
   Cr Revenue                           555,018  
Dr Cost of sale                     541,110  
   Cr Inventory                         550,000

Discussion

The value of the net investment in the lease represents the present value of the lease payments and the unguaranteed residual value: 8,890 + 555,018 = 563,908.

Revenue is recognised at the lower of the lease receivable and the fair value. In this case, it is the lower of 555,018 and 575,000.

Cost of sale is 541,110, which represents the carrying amount less the present value of the unguaranteed residual value. Since this value is capitalised in the net investment in the lease, it is not expensed as well.

Inventory is written off in full, with the present value of the unguaranteed residual value recognised in the net investment in the lease.

Initial direct costs do not apply and are not capitalised. The costs are not part of the definition of initial direct costs.

Operating Leases

If the lease is an operating lease, a manufacturer or dealer lessor does not recognise any selling profit upfront. This is because an operating lease is not equivalent to a sale of the underlying asset. Instead, lease income is recognised on a straight-line basis (or another systematic basis) over the lease term.

Conclusion

Manufacturer or dealer lessors need to follow unique principles under IFRS 16 that differ significantly from standard finance leases. The most important factor is the recognition of revenue, cost of sales and selling profit or loss that is recognised upfront, at commencement of the lease.

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