Analysis of Operating and Capital Lease - Assignment Example

Leasing Assignment The recent past has seen an increase in leasing amongst many big corporation especially due to cost minimization measures. International Gaap: Generally Accepted Accounting Practice Under International Financial Reporting Standards IAS 17 classifies leases as either Finance lease or operating lease and continues to postulated that to determine whether a company has an operating lease and capital lease, there must be substantial transfer of risks and rewards incidental to ownership from the lesser to the lessee, there must be a bargain purchase option, the lease term must be greater than 75% of the economic life of the leased asset and that the leased asset must be of specialized nature. To this regard, it is evident that United Parcel Service (UPS) is a company that incorporates both the capital or financial lease and the operating lease. The company has an aircraft that is as a result of a capital lease and since it is a long term lease the payment of the principal amount will be paid after 12 years (2009-2021) but some commitments associated with the lease of the aircraft has been legally defeased. Therefore, IAS 17 provides that United Parcel Service recognize the aircraft as both asset and liability at a value that is equal to the lower Present Value and the present value of MLP discounted at the leasers other use incremental borrowing rate (Oppermann 107). Additionally, the asset must be depreciated and with lease rentals paid, the organization must apportion between finance cost and a reduction in liability. The transaction is recorded as follows; 2007 2006 Aircraft $2,573 $2,383 Less: Accumulated amortization 416 390 $2,157 $1,993 The operating lease for UPS is considered to be the rental contract which is short term in nature. The leased asset and the liability associated with the asset are not included in the lessee balance sheet but the lessee may hold the same rights that the lessor holds (Oppermann 110). To determine whether the United Parcel Service have an operating and financial lease, various factors are taken into consideration such as the tax incentives and the non-tax incentives generated by the company under study. In the case of tax incentives if the company has a lower tax rate then the incentives will be classified as operating lease whereas if the tax rate is higher, then it is classified as a capital or financial lease. Another determinant factor of whether the company has both operating lease and capital lease is by the fact that it meets all the prerequisites associated with the operating and the capital lease. For UPS this fact is evidenced by the availability of the aircraft that represents the capital lease and the rental contract which is short term and represents the operating lease. A Brief Summary of UPS United Parcel Service of North America, Inc. (UPS) is a shipment and logistics company that is well known for its wide variety of services it offers. The services include delivery of trucks and uniforms binding and lamination, printing services, computer services among others to different parts of the world (United Parcel Services 2014). UPS also provides its customers with an online portal that provides the customers with a platform that is not only convenient, but also provides a faster means of printing the documents online without necessarily having to visit the company in person. UPS facilitates its employees who are in charge of sales in large areas by enabling them to use the UPS store as a base for shipping and receiving the documents accompanying the sale process. Additionally, UPS also provides an Alternate Delivery Location (ADL) service for the delivery of their products to the customers, this service ensures that the goods delivered are secure from theft and harsh weather conditions until the customers have picked them. UPS stores are located in easy to access regions which has proved to be convenient by reducing the costs that the customer has to incur in travelling to obtain the services offered by UPS. This as a matter of fact has had a positive effect on the company by increasing the customer turnover in the company who want to access the services that are being provided thus an increase in the revenues to the company. UPS has also created employment opportunities to the residents of North America and also self-employment opportunities which enables people to be innovative and also providing them with incomes which has become a corporate social responsibility of the company as a way of giving back to the society within which the company operates. United Parcel Services (UPS) operates under the Air Delivery and Freight Services to provide services to the customers. What an operating lease and capital lease is and the details of the operating lease and the capital lease A lease is a contract whereby the right to possess and enjoy a real estate is moved from the lessor who is the person or company transferring the right to the lessee, the person receiving the rights for a given time (Oppermann 118). A lease is classified according to the term of repayment of capital lease and the operating lease. Capital lease also referred to as financial lease is a long term lease. A lease is regarded as a capital lease if it meets any of the financial requirements which are; i. There exists an option to buy the asset at the end of the given lease period at a bargain price. ii. If it transfers title of the asset to the lessee by the end of the lease period. iii. If the lease period is equal to or greater that 75 percent of the estimated economic life of the asset. iv. During the inception of the lease period, the present value of the least lease payments is at least 90 percent of the fair value of the leased asset to the lessor. Oppermann (127) states that operating lease, also known, as service lease on the other hand, is a short term lease which gives the lesser the right to use the leased asset but they do not give the lessee all the privileges that are associated with the ownership of the asset thus an operating lease fails to satisfy the requirements associated with a capital lease rather it satisfies the following conditions; i. They are not fully amortized which means that the lease agreement is written for significantly less than the economical life of the asset. ii. The operating lease has a clause called the cancellation clause that gives lessor the right to terminate the lease before the lapse of the period in the initial agreement. iii. Operating lease incorporates financing and also maintenance services Operating lease is very useful in any company in that the short term leases are very convenient if the company wants to use an asset for a short period of time as opposed to purchasing the asset which has a long procedure. Similarly, maintenance of the asset under lease is provided by the lessor plus other services that the asset may need. Also the cancellation options available are precious in the sense that the risk of obsolescence is passed from the lessee to the lessor. In conclusion, both operating lease and capital lease have an advantage to the company such that the tax on depreciation of an asset may reduce the principal payments that are to be paid back at the end of the given time of the lease. Additionally, leasing also provides a cheap source of funds for the companies that use the leased assets because it provides both long term and short term sources of financing with little transaction costs involved than in procuring the asset for the company. However, it is important that companies critically analyze the conditions for the leases so as to ensure the leases have economic benefits to the company (Dillman 32). Works Cited Dillman, Rodney J. The Lease Manual: A Practical Guide to Negotiating Office, Retail, and Industrial Leases. Chicago: American Bar Association, Section of Real Property, Probate and Trust Law, 2007. Print. International Gaap: Generally Accepted Accounting Practice Under International Financial Reporting Standards. Chichester, West Sussex, U.K: John Wiley, 2013. Print. Oppermann, H.R.B. Accounting Standards. Lansdowne: Juta, 2009. Print. United Parcel Services, UPS Companies. Retrieved from http://www.ups.com/content/corp/companies/index.html?WT.svl=3DeS= Read More