Final answer:
To be classified as a sales-type or direct financing lease by the lessor, three conditions must be met: transfer of ownership, a bargain purchase option, and the lease term is for the major part of the economic life of the asset. Additionally, the present value of lease payments must be substantial in relation to the fair value of the asset.
Step-by-step explanation:
For a lease to be classified by the lessor as a sales-type or direct financing lease, generally accepted accounting principles (GAAP) require all of the following three conditions to be met:
Additionally, if the present value of lease payments equals or exceeds substantially all of the fair value of the leased asset, it is often classified as a sales-type or direct financing lease. The lessor should recognize interest revenue over the lease term, which separates these types of leases from operating leases, where the lessor continues to recognize the leased asset in their balance sheet.