...relating to direct financing, sales type and operating leases in regards to lease types and structure by the Financial Accounting Standards Board (FASB). A lease is defined as a contractual agreement a lessor and a lessee. The lessor is the organization who owns the property or asset, in this situation trucks. The lessee is the company that wishes rent the asset, trucks, for specific amount of time. For accounting purposes, operating or capital lease, the type of lease must be determined. There are four criteria used to determine the type of lease and the accounting method used in conjunction with each. The four criteria are: 1. Transfer of Ownership by which the asset is transferred to the lessee at the end of the lease term. 2. Bargain purchase option where the lease agreement contains a an option for the lessee to purchase the asset at a significantly reduce price below fair market value. 3. The lease term is equal to or greater than 75 percent of the estimated economic life of the asset, unless the lease begins during the last 25 percent of the asset’s economic life. 4. Minimum lease payments are equal to or greater than 90 percent of the fair market value of the asset at the onset of the lease agreement. This excludes associated costs such as insurance, maintenance and taxes paid by the lessor. (Financial Accounting Standards Board, 2008 section 840-10). Minimum lease payment calculation does not pertain if the lease is entered in the last 25 percent of the...
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...Benefits of a Capital Lease December 3, 2012 MEMORANDUM TO: Trucking Company, Inc. FROM: Accountant DATE: December 3rd, 2012 SUBJECT: Benefits of a Capital Lease CC: John Smith, Supervisor In response to your request for more information on the topic of leases, I will explain the different aspects of leases to help you get a better understanding of the topic so that you may make an informed decision on which type of lease is best for your company. Capital Leases A capital lease emulates an installment purchase of an asset. This type of lease transfers the benefits and risks associated with ownership of an asset to the lessee (Schroeder, Clark, & Cathey, 2011). According to ASC 840-10-25 (FASB, 2009) (IAS 17), a lease must meet at least one of the following four criteria to be considered a capital lease: a. Ownership is transferred by the end of the lease agreement. b. There is a chance to purchase at a bargain price. c. The length of the lease is 75% or more of the assets life. d. The sum of the minimum payments, calculated at present value, exceed 90% of the assets fair value. Criteria c and d do not apply if the term of the lease begins in the final 25% of the assets useful life. Two Types of Capital Leases There are two types of capital leases concerning the lessor; direct financing and sales-type leases. For a capital lease to be considered a direct financing or sales-type lease, according to ASC 840-10-25 (FASB, 2009), both of the following...
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...The purpose of this response is to determine the difference between direct finance leasing, sales-type leasing or an operating lease for Company ABC. To accomplish this, I will discuss a little background on all of the options and the advantages and disadvantages of a lease. This will aid company ABC in determining the best course of action for acquiring equipment in the future. First, what is a lease? “According to the Federal Accounting Standards Board (FASB), a lease is an agreement conveying the right to use property, plant, and equipment usually for a stated period of time” (Lee, 2003). Essentially a lease is an agreement between a lessee and lessor whereby the lessor “rents” their equipment to the lessee in return for a determined payment or series or payments over an agreed time period. SFAS No. 13 has specified criteria by which lease structures are classified into two basic types of leases, capital and operating leases. If all of the benefits and risk of ownership are transferred to the lessee, the FASB considers it to be a capital lease (Lee, 2003). The capital lease is then further classified in to a sales type lease and direct financing lease. A sales-type lease has a fair value amount different from its carrying amount (Lee, 2003). A sales-type lease can involve any type of property, plant and/or equipment. To be considered a capital lease it must do one of the following; (1) transfer of ownership to lessee, (2) option to purchase the property at a bargain price...
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...Operating Lease Firms often choose to lease long-term assets rather than buy them for a variety of reasons, including the tax benefits, flexibility for changes in the future needs, and so forth. There are two ways to account for the leases, operating lease and capital lease. In the operating leas, the lessor only transfer the right to use the property to the lessee, and the lessee needs to return the property to the lessor at the end of the lease term period. In ASC 840-10-25-1, we could find the tests used to determine whether a lease should be accounted for as a operating lease or capital lease. A lease should be classified as a capital lease if it meets any one of the four criteria stated in ASC 840-10-25-1. The lease classification criteria are: (a). There is a transfer of ownership to the lessee at the end of lease form. (b). The lease contains bargain purchase option to purchase the property at the end the lease period. (c). The lease term is equal to 75 percent or more of the estimated economic life of the leased property. (d). The present value of the lease payments, discounted at an proper discount rate, exceeds 90 percent of the fair market value of the property (ASC 840-10-25-1). According to ASC 840-10-25-42, besides for those four basic classification criteria, the lessor shall consider the following incremental criteria: (a). Collectability of the minimum lease payments is reasonably predictable. (b). No important uncertainties surround the amount of unreimbursable...
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...12-32 Operating Leases: Income Effects of Constructive Capitalization Eugene A. Imhoff, Jr.. Robert C. Lipe and David W. Wright Eugene A. Imhoff, Jr. is Professor at University of Michigan, Robert C. Lipe is Associate Professor at University of Colorado at Boulder and David W. Wright is Associate Professor at University of Michigan. SYNOPSIS: Lease contracts written in 1994 in the U.S. have been estimated at over $140 billion (London Financial Group Ltd. 1996). The amount of leasing activity continues to grow, particularly op erating-type leases which provide a source of off-baiance sheet financing. However, a recent publication by an international group of representatives from the FASB and six other national and international accounting standard setting bodies suggests that iease accounting should require alt lease contracts to be capitalized as assets and liabilities (McGregor 1996). This suggestion has also been made by the Association for Investment Management and Research (AMIR) in a December 1993 white paper. A previous Horizons paper by Imhoff et al. (1991) illustrated how to constructively capitalize operating leases. However, this prior study focused exclusively on the balance sheet effects for a single period, and assumed the income statement effects were negligible. The current study cites evidence that suggests the income statement effects may be material, and illustrates how to estimate the impact of constructive capitalization of operating leases on both operating...
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...have researched the FASB website for information on leases and lease structure issues, in particular the current practices and thought related to direct financing, sales type, and operating leases. The following is a brief explanation of the results and also a recommendation of an approach that the client can use to evaluate and capitalize on the opportunity of adding the new customer. The FASB has outlined certain criteria for classifying leases as either capital leases or operating leases. In SFAS No. 13 the criteria for classifying a lease as a capital lease are; the lease transfers ownership, the lease contains a bargain purchase option, the lease term is equal to 75 percent or more of the estimated remaining economic life, and at the beginning of the lease term the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property less any related investment tax credit retained by the lessor (Schroeder, Clark, & Cathey, 2011). The lease only has to meet one of those criteria to be a capital lease. If none of these criteria are met then the lease is classified as an operating lease. Leases can also be classified as a sales type lease or a direct financing lease. For a lease to be classified as a sales type or direct financing lease the lease would have to meet one of the criteria listed above plus two other criteria. The other two criteria are; collectability of the minimum lease payments is reasonably predictable and no important...
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...to Client Request ACC/541 September 2, 2013 To: From: Subject: Lease Type and Lease Structure This memo includes research on leases and lease structure. Through intensive research on the Financial Accounting Standards Board (FASB), three sub-types of leases were found for lessors to account for the leases. The three sub-types are direct financing, sales-type, and operating leases. The international accounting standards board (IASB) and FASB are proposing a draft for lease accounting. The critics are disputing some of the concerns with operating lease financial reporting. This memo will address the proposal changes for operating leases. Also included is a lease type recommendation for the client. According to FASB ASC 840-30-05-4 (2009), lease capitalization includes direct financing and sales-type leases. These types of leases are recognizable by meeting one of the four criteria’s. A lessee under the capital lease method recognizes the lease according to FASB ASC 840-30-25-1 (2009), as an asset and as a commitment. The lessee accounts for the lease commitment in accordance to FASB ASC 840-30-30-1 (2009), at inception when the amount is equal to the present value (PV). In addition, the lease term will exclude the payment portion that represents specific cost such as insurance, maintenance, and taxes. For capital leases, a lessee recognizes lease assets and liabilities on the balance sheet (FASB, 2013). The lessee will determine...
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... Wren Co. leased a building to Brill under an operating lease for ten years at $50,000 per year, payable the first day of each lease year. Wren paid $15,000 to a real estate broker as a finder’s fee. The building is depreciated $12,000 per year. For year 1, Wren incurred insurance and property tax expense totaling $9,000. Wren’s net rental income for year 1 should be a. $27,500 b. $29,000 c. $35,000 d. $36,500 3. (a) Net rental income on an operating lease is equal to rental revenue less related expenses, as computed below. Rental revenue $50,000 Depreciation expense (12,000) Executory costs (9,000) Finder’s fee ($15,000 ÷10) (1,500) Net rental income $27,500 The finder’s fee ($15,000) is capitalized as a deferred charge at the inception of the lease and amortized over ten years to match the expense to the revenues it enabled the lessor to earn 11. On January 1, year 1, Mollat Co. signed a seven-year lease for equipment having a ten-year economic life. The present value of the monthly lease payments equaled 80% of the equipment’s fair value. The lease agreement provides for neither a transfer of title to Mollat nor a bargain purchase option. In its year 1 income statement Mollat should report a. Rent expense equal to the year 1 lease payments. b. Rent expense equal to the year 1 lease payments less interest expense. c. Lease amortization equal to one-tenth of the equipment’s fair value. d. Lease amortization equal to one-seventh of 80% of the...
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...OFF-BALANCE SHEET FINANCING 1 Leases: Off-Balance Sheet Financing and the Strive for Transparency Today Brian Edman A Senior Thesis submitted in partial fulfillment of the requirements for graduation in the Honors Program Liberty University Spring 2011 OFF-BALANCE SHEET FINANCING Acceptance of Senior Honors Thesis This Senior Honors Thesis is accepted in partial fulfillment of the requirements for graduation from the Honors Program of Liberty University. 2 ______________________________ Gene R. Sullivan, Ph.D. Thesis Chair ______________________________ James B. Shelton, Ph.D. Committee Member ______________________________ Stephen R. Bowers, Ph.D. Committee Member ______________________________ James Nutter, D.A. Honors Director ______________________________ Date OFF-BALANCE SHEET FINANCING Abstract In today’s world, leases appear far and wide; they are commonplace throughout the business and accounting frontiers. Accounting for leases, however, is not so clear cut. Since there are various ways to account for leases, many companies pick and choose which they feel best suits their situation, even when this sweeps dirt under the rug along 3 the way. The financial procedures for dealing with leases should entail benefits as well as limitations to ensure each company is fairly representing all of its financial information. Off-balance sheet financing is one of the hot topics in accounting for leases because of the implications it imposes...
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...potential for growth. As requested, I have spent the past few days examining the current FASB standards on leases to determine what the best course of action for Schmoe Trucking would be. There are a number of options when it comes to leasing, and it is vital that each option is examines in order to determine the proper course of action. There are a few things about leases that must be looked at before determining how to proceed. Leases are broken down into two categories; operating leases and capital leases. A capital lease is one that meets certain criteria and capital leases can be broken into subcategories; sales type leases and direct financing leases. We will be looking at the differences between sales type leases, operating leases, and direct financing leases in relation to the proposed acquisition of additional trailers. The first step is to determine if a lease is an operating lease or a capital lease. A capital lease will meet at least one of the following criteria. SAFS No. 13 outlines the capital lease criteria to be as follows; transfer of ownership of the leased item upon completion of the lease period, a bargain option is included in the terms of the lease, the period of time covered by the lease is at least 75% of the expected economic life, unless the period falls within the final 25% of the expected economic life, or the present value of the lease payments is the equal to or exceeds 90% of the fair value of the leased item (FASB Accounting Standards Codification...
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...ACCOUNTING FOR LEASES CONTENT ANALYSIS OF EXERCISES AND PROBLEMS Time Range (minutes) 5-10 Number E21-1 Content Operating Lease. (Easy) Annual rental payments, no renewable option clause, executory costs. Lessee's journal entries to record agreement, payments, expenses. Capital Lease. (Moderate) Calculation of rental payments made at end of year. Table summarizing lease payments, interest expense. Journal entries. IFRS differences. Capital Lease. (Moderate) Payments made at beginning of year. Table summarizing lease payments, interest expense. Journal entries. Direct Financing Lease. (Moderate) Calculation of rental receipts, made at end of year. Table summarizing rental receipts, interest revenue. Journal entries. Direct Financing Lease. (Easy) Journal entries to record contract, first rental receipt. Direct Financing Lease / Capital Lease. (Moderate) Table summarizing lease and interest payments. Journal entries for lessor and lessee. Sales-Type Lease. (Moderate) Payments made at end of year. Calculation of selling price (fair value). Table summarizing lease receipts, interest revenue. Journal entries. Sales-Type Lease. (Moderate) Payments made at beginning of year. Calculation of selling price (fair value). Table summarizing lease receipts, interest revenue. Journal entries. Sales-Type Lease / Capital Lease. (Moderate) Computation of lease payments. Journal entries for lessor and lessee. Operating Lease / Sales-Type Lease. (Moderate) Accounted for as operating, should have...
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...Ratings and Off-Balance Sheet Operating Leases Prepared by: Sidra Manzoor Wajeeha Masood Sidra Waseem Nuzhat Gul BBA-MBA-8 Faculty of Management Sciences International Islamic University, Islamabad. Prepared for: Ma’am Najam-us-Saher Faculty of Management Sciences International Islamic University, Islamabad. CASE STUDY Air Canada: Bond Ratings And Off-Balance Sheet Operating Leases Question #1 How should the operating lease be treated in the assessment of quality of firm’s bonds? Answer A rating agency assigns a bond to a rating category. The standard and poor’s publishes an internet version of Corporate Ratings Criteria. The process is based on an analytical framework that considers both qualitative and quantitative issues. The process begins by assessing the issuer’s competitive position and operating environment and then using the company’s business risk profile to determine the level of financial risk appropriate for any rating category. Financial risk is basically assessed financial ratios and these ratios are used to assess, a company’s profitability, interest coverage, leverages and cash flow adequacy. Before analyzing ratios, a general assessment of the accountability quality of the financial statements is conducted. A number of accounting issues reviewed such as the off-balance sheet liabilities such as operating leases. Adjustments for it are made to ensure that the companies are comparable. The adjustment for lease is especially important in...
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...* Question 1 2 out of 2 points | | | Which one of the following is not correct? | | | | | Selected Answer: | C. For debt issued at a discount: interest expense reported on the income statement equals cash interest payment less amortization of the discount. | Answers: | A. For debt issued at par: interest expense reported on the income statement equals the cash paid for interest. | | B. For bond repurchases, the gain or loss is the difference between the book value and the repurchase amount. | | C. For debt issued at a discount: interest expense reported on the income statement equals cash interest payment less amortization of the discount. | | D. For debt issued at a premium, interest expense reported on the income statement equals cash interest payment less amortization of the premium. | | E. None of the above | Response Feedback: | Rationale: For debt issued at a discount, interest expense reported on the income statement is cash interest paid plus amortization of the discount. | | | | | * Question 2 2 out of 2 points | | | Morse Corp. sells $200,000 of bonds to private investors. The bonds have a 9% coupon rate and interest is paid semiannually. The bonds were sold to yield 8%. What periodic interest payment does Morse make? | | | | | Selected Answer: | D. $ 9,000 | Answers: | A. $16,000 | | B. $ 8,000 | | C. $18,000 | | D. $ 9,000 | | E. None of the above | Response Feedback: | Rationale: Coupon...
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... 2011 Subject: FASB Lease Practices and Client Recommendation I have researched and analyzed the different Financial Accounting Standards Board (FASB) practices related to lease options, which our trucking client may want to consider in his or her new business opportunity. Leases are a way in which companies can finance a business project. According to the official FASB website, a lessor may record a lease transaction as a sales type lease, a direct financing lease, or an operating lease. A sales type lease and a direct financing lease are different ways to record a capital lease (Standards, 1976). One lease option the trucking client has is to record the leases as direct financing leases. Direct financing leases are recorded when the carrying value of the lease is equal to the fair value of the leased property at inception (Standards, 1976). This lease arrangement is a sales and financing transaction. When a direct financing lease is recorded, only the interest received is recognized on the lessors books as income. The cash outflow is equal to the carrying value of the asset, and the cash inflow is equal to the lease payments (CFA, 2011). Another lease option the trucking client has is to record the leases as sales type leases. A sales type lease is similar to a direct financing lease, except upon inception of the lease; profit on a sale is recognized. The profit recorded at the beginning of the lease term is the present value of the lease payments, less the cost...
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...541 24, December 2012 Memorandum To: Supervisor From: Sarah Dixon Re: Leases and lease structure issues It has come to my attention of our client’s concern regarding the uncertain relationship with a customer who may potentially offer the company a significant growth benefit. The following memo will address the client’s concern and recommend a solution to the problem, giving a summary of several different types of leases. One of the most important issues here lies with understanding that the client’s main concern is trying to make as much profit as he possibly can for his regional trucking company. The opportunity offered to this client could potentially be very profitable if handled in the correct manner. The client has the option to either purchase twenty more trailers to accommodate this customer or use an alternative means of acquiring these assets known as leasing (Schroeder, 2011). I will explain leases and lease structure issues of several different types of leases including direct financing leases, sales type leases, and operating leases which could greatly benefit this client. A lease is a contractual agreement between the lessee, or the user, to pay the lessor, or the owner, for the use of an asset or services. Leases are classified under the Financial Accounting Standards Board (FASB) under the number 840. The lessee is the receiver of the services or assets under the lease agreement, and the lessor is the owner of the services or assets (Statement...
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