Financial_Accounting_Research

Introduction The memo addresses the issue faced by a client of establishing a relationship with a new customer. The deal with the new customer has great potential for future growth. The new customer has offered to the client an opportunity requiring the use of 120 trailers; which are 20 trailers more than what is presently owned by the trucking company. For this purpose, the issues in the Financial Accounting Research System (FARS) in relation to the leases and lease structures have been explained in brief. FARS is a software package which is just like an accounting tool that helps to resolve the accounting issues. Financial Accounting Standards Board (FASB) has developed this software. Issues Criteria for the sale lease back accounting There are special criteria for the sale lease back accounting. The sale-leaseback accounting shall be used by a seller-lessee only if a sale-leaseback transaction includes all of the following (Summary of Statement No. 98): a. A normal leaseback (as described in paragraph 8) b. The terms and provisions of payment that properly and sufficiently establish the buyer-lessor’s initial and upholding investment in the property. c. The terms and provisions of payment that carry-over all of the other risks and rewards of ownership as demonstrated by the absence of any other continuing involvement by the seller-lessee. A normal leaseback is the relationship between the lessee and lesser involving the active use of the property by the seller and lessee in consideration for payment of rent, taking in the contingent rentals that are based on the future operations of the seller-lessee and leaves out the other continuing involvement provisions explained in this Statement (Summary of Statement No. 98). Capital Lease Criteria (Accounting Study Guide, 2008) The following aspects cover the capital lease criteria: • There should be a transfer of the ownership of the property to the lessee at the end of the lease term. • It should contain a bargain purchase option. • The term of the lease should be equal to 75 percent or more of the economic life of the leased property. • The present value of the minimum lease payments at the beginning of the lease term should be equal to or more than 90% of the excess of the fair value of the leased property. The leases are classified by the lesser as follow (Accounting Study Guide, 2008): • Sales-type Leases: They are the leases that fulfill one or more of the capital lease criteria and both sales-type and direct financing lease criteria. It gives the profit or loss of the dealer or manufacturer to the lessor. • Direct Financing Lease: It is the lease that fulfills one or more of the capital lease criteria and both the direct financing lease and sales-type criteria, however, it does not gives the profit or loss of the dealer or manufacturer to the lessor. • Operating Leases: All other leases. Sales-type and Direct Financing Lease Criteria (Accounting Study Guide, 2008) • The ability to collect the minimum amount of lease payments is fairly foreseeable. • There are no significant uncertainties that surround the amount of costs that cannot be reimbursed and still have to be incurred by the lessor. Conclusion In accordance with the current accounting standard, a lease should be capitalized if it transfers substantially all the benefits and risks of the ownership of property. In order to determine the conceptual nature of lease, there are different approaches. The first is an executory contract approach under which any leased asset should not be capitalized because the contract is an executory one and the lessee does not own the property. The second is a whole asset approach under which the leases that are similar to the installment approach. The third approach says that all the long term leases (involving the assets that possess a long term right to use) should be capitalized (Zima). Under the direct financing lease, the residual value is included in the lessor calculations whether guaranteed or unguaranteed. Under the sales type lease, the residual value is a part of the sales revenue and cost of goods. The entries in the sales type lease are the same as the direct financing lease except for the entry at the commencement of the lease which must record the sales and cost of goods sold and the sales type lease consists of the profit margin of the dealer or manufacturer. The lessor earns a gross profit on the sale and interest as the sale is financed (Zima). Under the direct financing lease, the lease payments are equivalent to the lease payments net of the executory costs plus the scrap value. The sales type lease and the direct financing lease are the kinds of capital lease and their accounting is done differently. The assets and liabilities are recorded at a lower amount out of the two of the present value of minimum lease payment or the fair value of the asset at the starting of the lease. Recommendation The company should accept the deal because it holds a good potential for the future growth of the company and it will also increase the capacity of the company because it requires 20 more trailers than its ownership of 100 trailers. It is a regional company and it can expand into other regions and areas as well. So, this deal could provide a reasonable basis for the opportunity of expansion for the company. References Accounting Study Guide (2008). Retrieved December 18, 2008, from http://www.accountinginfo.com/study/lease-01.htm Summary of Statement No. 98. Financial Accounting Standards Board. Retrieved December 18, 2008, from http://fasb.org/st/summary/stsum98.shtml Zima, P. Leases. Retrieved December 18, 2008, from http://mos.uwo.ca/courses/361/Ch%2020%20kieso%20pp%20slides%20(8e).ppt#1