MEMO Date: July 18, 2011 3 Subject: Leases and Lease Structure Issues 4 To: Regional Trucking Company 5 From: Bob Stanton This memo will cover the current practice and thought related to direct financing, sales type, and operating leases. I understad that Regional Trucking Company have limited time to cover all aspects of these areas. Disclosure Requirements for Capital Leases SFAS No. 13 also requires the disclosure of additional information for capital leases.
The following information must be disclosed in the lessee’s financial statements or in the accompanying footnotes: 1. The gross amount of assets recorded under capital leases as of the date of each balance sheet presented by major classes according to nature or function 2. Future minimum lease payments as of the date of the latest balance sheet presented, in the aggregate and for each of the five succeeding fiscal years 3. The total minimum sublease rentals to be received in the future under noncancelable subleases as of the date of the latest balance sheet presented 4.
Total contingent rentals (rentals on which the amounts are dependent on some factor other than the passage of time) actually incurred for each period for which an income statement is presented. The lessor should report a lease as a sales-type lease when at least one of the capital lease criteria is met, both lessor certainty criteria are met, and there is a manufacturer’s or dealer’s profit (or loss). Major steps are involved in accounting for a sales-type lease by a lessor.
The amount to be recorded as gross investment is the total amount of the minimum lease payments over the life of the lease, plus any unguaranteed residual value accruing to the benefit of the lessor. Once the gross investment has been determined, it is to be discounted to its present value using an interest rate that causes the aggregate present value at the beginning of the lease term to be equal to the fair value of the leased property. The rate thus determined is referred to as the interest rate implicit in the lease
Applying the interest method results in a constant rate of return on the net investment in the lease. The difference between the gross investment and the unearned interest income is the amount of net investment, which is equal to the present value of the gross investment. The net investment is classified as a current or noncurrent asset on the lessor’s balance sheet in the same manner as all other assets. Income from sales-type leases is thus reflected by two amounts. 1.
The gross profit (or loss) on the sale in the year of the lease agreement 2. Interest on the remaining net investment over the life of the lease agreement. When at least one of the capital lease criteria and both lessor certainty criteria are met, but the lessor has no manufacturer’s or dealer’s profit (or loss), lessors account for the lease as a direct financing lease. As with a sales-type lease, each payment received for a direct financing lease must be allocated between interest revenue and recovery of the net investment.
Because the net receivable is essentially an installment loan, in the early periods of the lease a significant portion of the payment is recorded as interest; but each succeeding payment will result in a decreasing amount of interest revenue and an increasing amount of investment recovery because the amount of the net investment is decreasing. Gross investment is determined in the same way as in sales-type leases, but unearned income is computed as the difference between gross investment and the cost of the leased property.
The difference between gross investment and unearned income is net investment, which is the same as in the sales-type lease. Initial direct costs in financing leases are treated as an adjustment to the investment in the leased asset. In each accounting period over the life of the lease, the unearned interest income minus the indirect cost is amortized by the effective interest method. Because the net investment is increased by an amount equal to the initial direct costs, a new effective interest rate must be determined in order to apply the interest method to he declining net investment balance. Lessees classify all leases that do not meet any of the four capital lease criteria as operating leases. The following disclosures are required for operating leases by lessees: 1. For operating leases having initial or remaining noncancelable lease terms in excess of one year: a. Future minimum rental payments required as of the date of the latest balance sheet presented in the aggregate and for each of the five succeeding fiscal years b.
The total of minimum rentals to be received in the future under noncancelable subleases as of the date of the latest balance sheet presented 2. For all operating leases, rental expense for each period for which an income statement is presented, with separate amounts for minimum rentals, contingent rentals, and sublease rentals 3. A general description of the lessee’s leasing arrangements including, but not limited to, the following: a. The basis on which contingent rental payments are determined b.
The existence and terms of renewals or purchase options and escalation clauses c. Restrictions imposed by lease agreements, such as those concerning dividends, additional debt, and further leasing Those leases that do not meet the criteria for classification as sales-type or direct financing leases are accounted for as operating leases by the lessor. As a result, the lessor’s cost of the leased property is reported with or near other property, plant, and equipment on the lessor’s balance sheet and is depreciated following the lessor’s normal depreciation policy.
Rental payments are recognized as revenue when they become receivable unless the payments are not made on a straight-line basis. In that case, as with the lessee, the recognition of revenue is to be on a straight-line basis. Initial direct costs associated with the lease are to be deferred and allocated over the lease term in the same manner as rental revenue (usually on a straight-line basis). However, if these costs are not material, they may be charged to expense as incurred.
The best course of action is to first choose a capital lease. It would probably be best if your company would buy the trucks at a later date. Since, the company is looking to lease, and probably at some point buy more trucks at some time in the future, the company should lease with an option to buy. The biggest worry that the company has is time. This being said, the best lease type to present is the sales-type lease.
Analysis into an applicable rental development for geting 20 additional truck dawdlers. point out that the category for an gear rental is determined by the requirements met in paragraph seven and eight of the Assertion of Monetary Accounting Requirements ( SFAS ) determine 13. Harmonizing to the Monetary Accounting Requirements Board ( FASB ) . the choices obtainable to the shopper are to amass an working rental. or a capital rental. comparable to a direct funding or gross revenues rental. The variations and results every rental has on the corporate are described beneath. Capital Lease V. Operational Lease
A capital rental is thought apart from as a financed rental. It’s reportable on the corporate’s fiscal statements as an plus and a legal responsibility and recorded on the present carnival market worth. In an effort to measure up as a capital rental. the understanding should run into not less than one of many undermentioned requirements: a ) Possession of the leased plus stays with the leaseholder on the terminal of the lease time period.
Usually the lease giver fees a bit of charge for rubric work. B ) The rental understanding incorporates a deal buy choice leting the leaseholder to purchase the gear at a financial worth a lot decrease than the jutting carnival market worth diploma Celsius ) The lease time period is not less than 75 % or extra of the estimated financial lifetime of the plus being leased vitamin D ) The minimal lease cost is the same as or greater than 90 % of the market worth of the leased belongings ( Monetary Accounting Requirements Board. 1980 )
In add-on to the above commonplace. a capital rental should apart from run into each of the next lease giver calls for: a ) The flexibility to roll up the minimal lease cost is reasonably predictable B ) No of import reserves encompass the sum of non-reimbursable prices non but incurred by the lease giver underneath the rental ( Monetary Accounting Requirements Board. 1980 )
An working rental is a rental that does non run into any of the capital rental calls for. It’s brief in time period and usually lower than 75 % of the financial lifetime of the gear. Working leases are merely rental understandings with mounted month-to-month funds and handled as such within the illustration of the corporate’s fiscal statements ( Schroeder. Clark. & A ; Cathey. 2011 ) . Operational leases are off steadiness sheet funding choices wherein the possession of the gear does non undergo to the leaseholder. it stays with the lease giver. Gross saless Kind Leases vs. Direct Financing Leases
A gross revenues sort rental should run into one of many capital rental requirements. each of the lease giver requirements and embody a maker or dealer web earnings or loss. A dealer or maker web earnings or loss “implies that the leased plus is an level of inventory listing and the marketer is gaining a gross web earnings on the sale” ( Schroeder. Clark. & A ; Cathey. 2011. p. 439 ) . Gross saless sort leases are most typical as a company for a corporation to market a merchandise. Much like a gross revenues sort rental. direct funding leases apart from should run into not less than one of many capital rental requirements and each lessor requirements. Nevertheless. in direct funding leases. there isn’t any maker or dealer web earnings or loss. The lease giver is in kernel a funding institution for gross acknowledgment intents ( Schroeder. Clark. & A ; Cathey. 2011 ) . Advice
The footing for the advice is as follows: The shopper is not sure how lengthy the connection with the brand new vendor will final. and there’s no profit to maintaining contemporary gear disbursal on the steadiness sheet. Moreover. there isn’t any benefit to the shopper to come back in right into a long-run rental understanding binding up working capital. It’s in one of the best involvement of the shopper to proceed with an working rental. as a result of brief rental interval. If the brand new concern relationship works out to be long run. the shopper can reassess the state of affairs and see a direct finance or gross revenues sort rental for the additional dawdlers.
Fiscal Accounting Requirements Board. ( 1980. Might ) . Assertion of Monetary Accounting Requirements No. 13. Accounting for Leases. 5-14. Norwalk. Connecticut: Fiscal Accounting Basis. Retrieved January 26. 2013. from
INTEROFFICE MEMORANDUM to: ABC Company from: Julian Michaels of ACC/541 subject: lease structure recommendation date: February 4, 2013
Research into an appropriate lease structure for acquiring 20 additional truck trailers, indicate that the category for an equipment lease depends on the criteria met in paragraph seven and eight of the Statement of Financial Accounting Standards (SFAS) number 13. According to the Financial Accounting Standards Board (FASB), the options available to the client are to get an operating lease, or a capital lease, such as a direct financing or sales lease. The differences and effects each lease has on the company are described below.
Capital Lease vs. Operational Lease
A capital lease is known also as a financed lease. It is reportable on the company’s financial statements as an asset and a liability and recorded at the current fair market value. In order to qualify as a capital lease, the agreement must meet at least one of the following criteria: a) Ownership of the leased asset remains with the lessee at the end of the lease term. Usually the lessor charges a small fee for title work. b) The lease agreement contains a bargain purchase option allowing the lessee to purchase the equipment at a price much lower than the projected fair market value c) The lease term is at least 75% or more of the estimated economic life of the asset being leased d) The minimum lease payment is equal to or more than 90% of the market value of the leased property (Financial Accounting Standards Board, 1980)
In addition to the above criteria, a capital lease must also meet both of the following lessor requirements: a) The ability to collect the minimum lease payment is reasonably predictable b) No important reservations surround the amount of non-reimbursable costs not yet incurred by the lessor under the lease (Financial Accounting Standards Board, 1980)
An operating lease is a lease that does not meet any of the
Cited: Financial Accounting Standards Board. (1980, May). Statement of Financial Accounting Standards No. 13. Accounting for Leases, 5-14. Norwalk, CT: Financial Accounting Foundation . Retrieved January 26, 2013, from http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175820908834&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs Purdue Online Writing Lab. (2010, April 21). Memos. Professional, Technical Writing. (C. Perkins, & A. Brizee, Compilers) West Lafayette, IN: Purdue University. Retrieved January 27, 2013, from