The decision regarding the equipment composition - Individual assignment - Essay Example

? Connie Johnson Week Three Individual Assignment August 28, of Phoenix Your company is currently facing a growth opportunity that requires the firm to make a decision regarding its equipment composition. The firm currently has 100 available trailers, but it would need an additional 20 trailers to obtain the contract. Since this opportunity was just presented to the company it would be hard for the firm to purchase an additional 20 trailers just to acquire a business contract that could be short term in nature. A better alternative for the company is to obtain the additional trailers through lease agreements. A lease is an agreement that gives a business or an individual the right to use plants, equipment, or machinery for a stated period of time. The lessee must make recurrent lease payments based on the terms of the contract. The most common lease agreement involves monthly lease payments, but the terms may vary depending on the contract. In 1976 the FASB issued SFAS No. 13, Accounting for Leases. This statement is considered a part of the generally accepting accounting principles. During the past 35 years after the creation of SFAS No. 13 the FASB has issued a total of six statements, six interpretations, and 11 technical bulletins on leases (Lee, 2003). When working with accounting for leases there are two different perspective or elements. The two elements are accounting for lessee and accounting for the lessor. The lessor is the original owner of the asset who rents its use to the lessee in change for a recurrent installment payment during the duration of the lease contract. There are two primary classifications of leases which are capital and operating leases. One of the most important aspects for SFAS No. 13 is that it establishes the four criteria necessary to classify a lease as a capital instead of an operating lease. If a lease fails to meet any of the four criteria established on SFAS No. 13 it fail to be classified as a capital lease. The difference between a capital lease and an operating lease is that a capital lease considers the property leased an asset in the accounting books of the company because at the end of the lease transfer of ownership occurs. The four criteria to classify a lease as a capital lease are: 1. The lease transfers ownership of the property to the lessee 2. The lease contains a bargain purchase option 3. The lease term is equal to 75% or more of the economic life of the leased property 4. The present value of the lease payments equals or exceeds 90% of the fair market value of the leased property (Weygandt & Kimmel & Kieso, 2003). The two primary classifications of capital or operating lease mentioned are from the perspective of the lessee. “Appendix No. 5, Determining Lessor’s Type of Lease – FASB, shows the evaluation process that can be used by a lessor to classify a lease” (Lee, 2003, pg. 12). From the lessor’s perspective a capital lease can be classified as a sales type lease, direct financing lease, or a leveraged lease. Each of the three types of lessor lease classifications can be defined differently. A sales type lease occurs when the fair value of the lease is different than its carrying amount and real estate is involved and ownership of the property is transferred, or when real estate is not involved and lease meets all four criteria under SFAS No. 13 and two additional lease criteria which are listed below: Collectibility of minimum lease payment is reasonably predictable No important uncertainties surround the amount of unreimbursable cost yet to be incurred by the lessor under the lease (Lee, 2003). The second lessor classification for a capital lease is direct financing lease. If the fair value and carrying amount of the lease are the same and the lease meets the two additional criteria mentioned in the definition of a sales type lease then the lease is classified as a direct financing lease. The third type of classification is the leveraged lease. In a leveraged lease a long term creditor intervenes to provide non recourse financing to the lessor in the leasing transaction. For leases to be classified as leverage leases it must also comply with the two additional criteria mentioned in the definition of a sales type lease. Any time that a lease fails to meet the two additional criterions the lease from the lessor’s perspective automatically becomes an operating lease. An operating lease is a rental agreement for the period of time specified in the contract in which the lessor lets the lessee borrow a property, plant, or equipment in exchange for a weekly, monthly, trimester, or yearly payment. The FASB also established rules for the treatment of leases associated with real estate property. Appendix No. 10, Classifying Leases Involving Real Estate, provides the guidelines that must be followed by accountants to determine the classification of real estate leases. FASB Interpretation No. 8 provides the rules to follow to classify real estate leases as operating leases. A special type of lease transaction is a sale-leaseback transaction. The rules that abide to type of lease transaction are covered by FAS 98. The FASB also provides guidelines for unusual lease transaction such as a lessee subleasing the property they acquired through a lease agreement. Leases for business combinations are also covered by FASB guidelines. The government often uses leases as a valuable tool to acquire property they cannot afford to buy or to acquire a property, plant, or equipment that is only going to be used in the short term. FASB Interpretation No. 23 “clarifies that portion of paragraph 28 of FASB Statement No. 13, Accounting for Leases, stating that leases of certain property owned by a governmental unit or authority shall be classified as operating leases” (FASB, 2011). The federal government often uses lease agreement to acquire property and equipment in many of its agencies. Budget cuts have made it harder for the Federal government to acquire assets. It is easier for a director of an agency to justify acquiring the use an asset through a lease than by purchasing it because lease can be arrange to only affect the agency’s budget in the short term. Leases are also advantageous because they give governmental agencies greater flexibility as often money for projects is approved in stages. References Fasb.gov (2011). Summary of Interpretation No. 23. Retrieved August 28, 2011 from http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010180 Lee, S. (2003). Capital and Operating Leases: A Research Report. Retrieved August 28, 2011 from http://www.fasab.gov/pdffiles/combinedleasev4.pdf Weygandt, J., Kieso, D., Kimmel, P. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons. Read More