Client_Response_1

Response to Client 1 Candace Schneider ACC/541 December 10, 2012 Rebecca Kime FASB RESEARCH RESULTS MEMORANDUM TO: Kane White, Consultant Engagement Supervisor FROM: Candace Schneider DATE: December 10, 2012 SUBJECT: Leases and Lease Structure Issues CC: Client Recently one was given the opportunity to research lease options for Regional Trucking Company. In summary, this company was approached by a new customer with an opportunity. This opportunity would require 120 trailers, which is 20 trailers more than the trucking company owns. Regional Trucking Company is uncertain how long its relationship with this client would last, but knows this opportunity presents a potential for significant growth for the company. In researching the lease options available that Regional Trucking Company may consider as identified on the Financial Accounting Standards (FASB) Board Website. One thought she would take a few moments to familiarize one with three specific lease options available to the client, which are direct financing, sales type, and operating leases. Direct Financing Lease A direct financing lease is “also known as a direct lease” (Wise Geek, 2003, para. 1). A direct lease is a type of lease that contains one or more of the characteristics of a capital lease as well as some additional requirements. This type of lease also involves non-leverage, which means a lessor cannot be a dealer or manufacturer. In this lease the lessor purchases the property like the 20 trailers for the main purpose of leasing the asset. The FASB states a lessor in this type of lease can recognize its gross investment in the lease and unearned revenue. The lessor can recognize unearned revenue if a difference exists between the gross amount investment and the cost of the leased asset. The lessor can amortize that income, which can create “a form of interest income throughout the life of the direct lease” for the lessor (Wise Geek, 2003, para. 3). This causes the lessor to benefit from the lease without committing any personal assets in the lease. “One of the key factors in arranging a direct financing lease is demonstrating that the monthly payments on the lease can and will be met without fail” (Wise Geek, 2003, para. 4). The benefits of leasing under this lease are 1. Allows the business to obtain assets without paying upfront 2. Creates a steady stream of income for a company 3. A company obtains tax benefits Sale Type Leases A sales type lease is a type of lease that contains one or more of the characteristics of a capital lease as well as some additional requirements. This type of lease also involves leverage, which means the lessor can be a dealer or manufacture. In this type of lease the lessor leases out its own assets that it uses to operate its business with. The assets are assumed as sold at the inception of the lease. During this time the lessor usually “sets a selling price above the asset cost, thus recognizing an immediate profit at the inception of the lease” (Putra, 2012, para. 27). The FASB states a lessor in this type of lease can recognize its gross investment in the lease, unearned revenue, and sales price. Under this lease agreement the lessee not the lessor depreciates the asset because the lessor is assumed to have sold the assets to the lessee even though the agreement is a leasing agreement. The benefit of leasing under this lease is: 1. Besides earning interest revenue the lessor receives a manufacturer’s or dealer’s profit Operating Leases Operating leases are leases that do not contain any of the characteristics of a capital lease, direct financing lease, and sales type lease. These leases are short-term and cancelable. In this type of lease the risks and benefits as well as ownership of leasing an asset from a lessor stays with the lessor. The lessor usually uses operating leases when he or she wants to lease short-term. This type of lease is the simplest of lease arrangements because the rentals are revenue to the lessor. In this type of lease the lessor leases the assets for the company but turns around and leases the same leased assets to its client. The benefits of this lease are 1. Usually results in acquiring a lower payment of any financing alternative 2. Helps a company to bypass capital budgeting restraints 3. Qualifies for off-balance sheet treatment 4. Can cause an improved Return on Asset 5. Result in higher reporting earnings at the inception of the lease Lease Recommendation One recommends that Regional Trucking Company uses a direct financing lease for this opportunity. This is because the company would benefit from the unearned revenue without committing any of its personal assets in the lease. The company can lease the 20 trailers it needs for the sole purpose of the opportunity. The company can gain revenue from leasing the assets to its clients. The information one has presented above is important in deciding what type of lease to consider. This information provides an overview of three types of leases and how these leases may benefit the client. One knows that the information one has provided will help one to decide what lease to consider. If one has any questions or concerns about leasing, please feel free to contact me any time. One will be glad to help with any questions or concerns the one may have. References Putra, L. D. (2012). Accounting for Lease: Operating and Capital Lease. Retrieved from http://accounting-financial-tax.com/2008/09/accounting-for-lease-operating-and-capital-lease/ Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2011). Financial Accounting theory and Analysis: Text readings and cases (10th ed.). Hoboken, NJ: Wiley. Wise Geek. (2003-2012). What is a Direct Financing Lease' Retrieved from http://www.wisegeek.com/what-is-a-direct-financing-lease.htm