Leases and lease structures - Essay Example

Leases and lease structures A lease contract in this concept has been defined as a contract that gives the lesseethe right to use the lessor equipment in our case the trailers for a specified period of time at a specified amount of lessee payments. The lease agreement enables the two parties to do a form of accounting transaction at a price deemed necessary. The Financial Accounting Standards Board (FASB) explains that a contract does need any entity to determine the initial direct costs that occurred before August, 2010, which is the official effective date for the changes made.

The lessee gets full control of the asset so leased and makes payments on monthly basis or as the contract specifies. The lessee gets right over tax benefits of interest and depreciation without violating the rights of the lessor. The lease arrangement is a form of sourcing for finance for a contractor. The contract should clearly indicate the specified assets to be leased, the size and even the cost and period of time it will be used. The period of contracting is non-cancellable. However, the options of extending or terminating the lease are and should be discussed and put on the contract.

This opens room for reassessment of the terms of the contract. The lessee should account for a lease at the initial stage as an a liability since he is under obligation to pay the interests and also recognize the specified item as an asset since he has control over the assets. This should be recorded at the present value of the lease amount to be paid eventually. The value of the lease is thus calculated by discounting the total amount of lease payments being made. Leases structures Sales type lease – this lease arrangement transfers all risks and benefits for using the specified asset to the lessee i.e. the contractor.

This is determined when the carrying amount of the assets is different from the fair value being offered by the lessor. The gains or losses incurred in this case should be accounted for according to the FASB. Ownership transfer is made to the lessee in this case. The operating lease does not transfer full ownership to the lessee. The risk of using the assets is not transferred to the lessee in this case. The minimum of lease payments to be made in this case are not reasonably determined and predicted.

The lessor doesn’t determine the amount of reimbursement that may occur due to uncertainties. The benefits associated with this are that ownership and risks rests with the lessor thus any technological obsolescence is at the owner’s mercies. This qualifies as an off-balance sheet treatment which in turn improves the over return on asset (Peter et al, 2006). The direct financing structure on the other hand, is one where the carrying value of the asset is determined as the same as the fair value being offered by the lessor.

All risks and ownership is substantially transferred to the lessee according to International Accounting Standard (IAS 17). This arrangement however, can easily predict the minimum lease payments to be made and uncertainties are minimal on the side of the lessor. Irregardless of the type of lease structure adopted, the initial recording of this arrangement is done at commencement of the contract but not at the interception date. The measures of lease assets and liabilities should be done before commencement and a discount rate determined that will be used for discounting and measuring the lease payments.

Costs incurred before commencement of the lease should be accounted for in the contract terms for both parties. The lease arrangement is generally a way of bypassing the huge capital budgets constraint and otherwise sourcing the assets required at a rental payment. The assets i.e. the trailer will be leased out and returned at the end of the contract and there are no worries of raising the huge amounts of purchasing them. Any option above can be chosen depending on its viability from the lessee’s view.

The terms of the contract should be clearly laid out in the contract (Richard, 2008). The recommended option in this case is to use the operational lease since the contract is bound to come to an end with the client. As a result transfer of risks and benefits is not wise in such a juncture. You should agree on the terms of the contract and lay it out that the obsolescence at the end of the contract is the owner’s loss. It’s important to put in mind that this is an alternative cheaper form of financing the contract for acquiring twenty trailers in a specified period of time.

Reference Leases, http://www.fasb.org/jsp/FASB retrieved on 15/11/2011. Peter K. N., Frank J. F., Jojy V. M.,2006, Equipment leasing EQUIPMENT LEASING vol. 8,, 6th Ed., John Wiley and Sons, Michigan, USA, pg.53-60 Richard W., 2008, International financial reporting standards for small and medium-sized enterprises: structuring the transition process, Gabler Verlag, Europe, pg. 127