Response to Client Request
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 the amount to record in accordance with FASB ASC 840-30-55-6 (2009), the minimum rental payments over the lease term is the number of months of the lease times the amount of the rental fee. The lessee residual amount is added to the minimum rental expense to get the minimum lease payment.
Direct Financing Lease
The direct financing leases must meet one of the four criteria’s set by FASB ASC 840-10-25-1 (2009). First, the lease transfers possession of the property to the lessee. Second, the bargain purchase option is part of the lease. Third, the terms of the lease are equivalent to 75% or more of existence. Fourth, the minimum lease payment is the present value is equivalent to 90% or more of the fair market. The direct financing lease according to FASB ASC 840-10-25-43 (2009), does not cause the manufacturer or dealer profit and or loss. In a direct financing lease according to FASB ASC 840-10-25-45 (2009), the carrying value, if different, and fair value of the property are equal at initiation.
Sales Type Lease
According to FASB ASC 840-30-25-5 (2009), under the sales-type lease the lessors will account for the same as direct financing leasing, except profit is recognizable upon the beginning of a lease. The interest income is recognizable throughout the duration of the lease. A sales type lease is a up front cash like transaction. Dealers and manufacturers offers sales type leases. The property according to FASB ASC 840-30-25-6 (2009), are under the assumption to sell at the beginning of the lease. The lessor will accrue interest during the lease term. The lessee will depreciate the asset in accordance to FASB ASC 840-30-45-3 (2009), separately amortizing lease.
Operating Lease
According to FASB ASC 840-10-25-30 (2009), an operating lease type does not meet the four requirements for a capital lease. An operating lease includes real estate and causes a manufacturer or dealer profit or loss to the lessor in accordance to FASB ASB 840-10-25-43(d) (2009). The operating lease according to FASB ASC 840-20-50-2 (2009), do not require lessees to recognize assets and liabilities. The lessee’s will disclose according to FASB ASC 840-20-50-1 (2009), the future payments and total minimum rental payments.
Proposed Changes
The international accounting standards board (IASB) and FASB are working on a combine project proposal to change the recognizing of operating leases (FASB, 2013). The new proposal would remove the difference involving operating and capital leases. The propose topic 842 recognizes assets and liabilities from operating leases on the balance sheet (FASB, 2013).
Lease Type Recommendation
A lease type recommendation for the client is the direct financing. The direct financing leasing will allow opportunity for growth. The direct financing lease will not cut into cost if the new partnership does not work out. Our client could end the lease and return the trailers if the partnership dissolves. The lessor owns the asset and will show amortize depreciation on the financial statements.
Conclusion
In conclusion, a capital lease will include the direct financing and sales type leases. The operating lease involves the other leases. The capital lease allows lessees to recognize the lease assets and liabilities on the balance sheet. The direct financing and sales type leases must meet at least one of FASB four criteria’s. On the other hand the operating lease type does not meet the four criteria’s. The IASB and FASB are working on a proposal draft to change lease accounting for operating leases.
Reference
- Financial Accounting Standards Board. (2009, July). ASC 840-30-05-4 (2009), Capital Leases Lessees Overview and Background. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-30-25-1 (2009), Capital Leases Lessees Overall Guidance. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-30-30-1, Initial Measurement Overall Guidance. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-30-55-6, Implementation Guidance and Illustrations. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-10-25-1, Lease Classification Criteria. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-10-25-43, Lesser Application of Lease Classification Criteria. ASC 840-10-25-45, Lesser Application of Lease Classification Criteria. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-10-25-30, Lessee Application of Lease Classification Criteria. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-20-50-1, Disclosure Lessee. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-30-25-6, Sales Type Lease. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2009, July). ASC 840-30-45-3, Other Presentation Matters. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2013, May). News Release: IASB and FASB propose changes to lease accounting. Retrieved September 1, 2013 from www.fasb.org
- Financial Accounting Standards Board. (2013, May). Proposed Accounting Standards Update Topic 842. Retrieved September 1, 2013 from http://www.fasb.org/cs/ContentServer pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176162613656
