Acc_541_-_Week_3_-_Individual_Assignment_-_Final

interoffice memorandum to: Professor from: Student subject: client request i date: date results of Lease research Lease financing is a significant means of procuring funds for businesses seeking to acquire asset items. Consequently, this leasing has specific implications to the transportation industry. In the United States, “more than half of all investment in equipment and software is currently being acquired under leases,” (Equipment Financing and Leasing Foundation, 2007). A clear understanding of the accounting concepts regarding operational strategies will help our client maintain operational flexibility, and mitigate strategic risks, through a period of fast growth. The Finance Accounting Standards Board (FASB), in 1976, issued its initial statement regarding reporting of leases within its Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases. SFAS 13 defines operating leases and capital, as follows: a “lease is a financing transaction called a capital lease if it meets any one of four specified criteria; if it is not, it is an operating lease” (Summary of Statement No. 13, 1976.). These four criteria are: • “The lease contains a bargain purchase option; • The lessee assumes ownership of the asset at the end of the lease term; • The present value of lease payments is equal to, or exceeds, 90% of the leased asset’s fair value; • The lease term equals, or exceeds, 75% of the leased asset’s estimated economic life, unless the lease begins within the last 25% of the leased asset’s economic life,” (Statement of Financial Accounting Standards No. 13, 1976). An operating lease is one that does not meet any of these four criteria. For lessees, operating “leases are treated as current operating expenses; for lessors, a financing transaction lease is classified as a sales-type, direct financing, or leveraged lease,” (Summary of Statement No. 13, 1976). A “sales-type, direct financing, or leveraged lease…must meet one of the same criteria used for lessees to classify a lease as a capital lease, in addition to two criteria dealing with future uncertainties” (Summary of Statement No. 13, 1976). Each lease type is recorded as an investment “under different specifications for each type of lease. Leases which do not the criteria are considered operating leases and are accounted for like rental property,” (Summary of Statement No. 13, 1976). A capital lease is recorded as a direct financing lease when there is no dealer or manufacturer profit or loss to record in association with the lease. The lessor is viewed as a lender, and each payment is allocated between interest revenue and investment recovery. Payments against the lease agreement also behave much as a mortgage or fixed-term loan in that early payments consist mostly of interest payments with very little of the total payment allocated to investment recovery. As each lease payment is received, the value of the receivable “is reduced by the full amount of the payment,” (Schroeder, Clark, & Cathey, 2011, 440). A sales-type lease is a capital lease associated with a dealer’s (or manufacturer’s) profit or loss. It implies that the leased asset is an item of inventory and the seller is earning a gross profit from the sale. As in the case with the direct financing lease, revenue from a sales-type lease is assigned to the gross profit or loss by the lessor as a result of the lease transaction, and interest on the remaining net investment over the term of the lease agreement. Lease financing may be more expensive than other methods of debt financing. However, it allows management to more quickly respond to economic changes in adjusting the company’s fixed asset requirements; leasing permits our client to try and choose the most productive equipment configuration. Current leasing standards determine whether, based on the rewards and risks of ownership, leases are capitalized. Our client should opt an operating lease to expand (temporarily) its’ truck fleet shipping capacity, due to the uncertainty of how long the relationship with the new customer may last. Though the operational lease term will consist of a small portion of the assets’ total useful life, our customer will have several options at the end of the lease; possibilities include equipment renewal, pursuit of the lease, equipment restoration, and the equipment may be purchased at market value. Currently, there is a fair amount of uncertainty regarding our client’s long-term growth projections; thus, the short-term leasing facilitates our customer’s immediate logistical needs without exposing it to excessive risk of losses. Operating leases will provide our client with certain distinct advantages in financial reporting; decreased corporate taxes, cash flow improvement, and no incidence of rent on the balance sheet. Because the cost of leasing the equipment are operating expenses deductible from profits, net income is reduced for tax purposes. References FASB. (1976). Accounting for leases: Statement of financial accounting standards no. 13. Retrieved from http://www.fasb.org/cs/BlobServer'blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820908834&blobheader=application%2Fpdf Levine, L. A. (2007). U.S. equipment finance market study: 2007-2008. Retrieved from http://www.elfaonline.org/pub/news/press/PDFs/EFMrktStudy07-08.pdf Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2011). Financial accounting theory and analysis: Text readings and cases (10th ed.). Hoboken, NJ: Wiley.