Operating Lease and Financing Lease - Essay Example

LEASING Name of Student Institution Affiliation Operating Lease and financing lease According to Collins, (2004) he differentiates between the operating and capital lease. An operating lease is recorded as an expense on the profit and loss as rent incurred. it used by companies as it favorable to accounting ratios by reducing debt and increasing liquidity. According to GAAP the asset lease is recorded as method of acquiring assets and in IFRS lease is recorded as short and long term liability (White, 2008). In this research involve study of ACE Corp which is an electrical manufacturing company that sells electrical parts for automobile. it will involve analyzing the financial statement that end at 31st December 2011 prepared on both IFRS and GAAP. The difference of both profit and loss and financial position at the end of the period will be compared to make the conclusions. This study will assist in study and know the appropriate method to use when recording the operating and financial lease. ACE Corp Overview It is a public company that is based in Detroit, Michigan. it also known as NASDAQ written in short as ACE and was started in 1996. It deals with manufacture of electrical parts and owns more than 12 percent of electrical market; it sells to major customer in the market who includes Toyota and Ford. It is listed at stock exchange with stock going for around 20-30 USD and market cap of over 10 million. In order to be included in Tokyo stock exchange it has to adapt to IFRS which is one of the compliances. Data collection In order to collect data in this study from the financial statements, the two types of lease are recognized and according to GAAP all leases are treated as capital lease unless fulfills the following tests so as to be recorded as asset lease in financial statement. A lease term should be more third quarters of the lease economic life, in this organization most of economic life is 4.1 years which don’t pass the test as it is less than the required. Lease should also transfer ownership to the lessee after the end of the lease period. In this company there is no transfer of ownership of completion of lease period of the three years hence no capital lease. The last test of differentiating a lease to be considered as an asset lease the lease has to have option of buy the lease at bargain purchase price and the economic recovery should be more than 90% of market value but this is not the case as it has 89% and hence it is am operating lease. Most companies prefer operating lease because they are flexible and company can easily change their assets. These leases are protected from being obsolete and also it makes the accounting easier as assets are not included and provide an improved ROA without restraints by the budget. As indicated above explains reasons why they had adopted GAAP in in financial statement reporting. Case Study In order for a lease to be adapted as either as an operating or capital leases under IFRS (PW Coopers) the following as to be considered: one has to consider the expected the monetary income advantage and dangers and risks that are accrued from the leased item in the company, another thing to be considered is how the lease is financed.. From the results in the financial statement of the company the lease can be characterized as capital asset as it does not meet the required characteristics. When the Financial statements are to change for the company to be listed in Tokyo Foreign exchange we going to study on differences that result from adoption of IFRS reporting system. Adjusting Journal Entry to conform to IFRS According to IFRS the 10000 USD paid as lease payments are to assume to be rent expense this is because the lease will be treated as a buying of an asset hence recorded in balance sheet under PLE of value of 26730 USD, the amount owing is recorded unlike the GAAP where it is recorded in profit and loss as an expense it will be record as a long term liability in the balance sheet of 9464 USD and interest of 1604 USD for the first year and after the three years the total will be similar to 30000 USD. After the adjustment the net profit is similar to 10500 USD as shown in the profit and loss.   accounts Dr Cr. Financing asset lease 26730   Lease obligation   23730 Capitalization record  Depreciation expense 8910   Accumulated depreciation   8910  Lease adjustment Lease obligation 18334   Current liability   8900 Long term liability 9434 Converting to long term  components Selling and admin expenses 15000   Item under lease   15000 Reclassification Tax payable 514   Item under lease   514 Changes in Financial Statements Changes in journal entries as shown above had effect in the financial statement as shown in the table below. GAAP 2011 IFRS 2011 Increase/decrease Account affected Amount USD Amount USD Sales 25000 25000 0 Cost of goods sold 175000 175000 0 Gross profit 75000 75000 0 Selling and admin expenses 31000 36000 5000 Income Before Interest & Taxes 44000 39000 5000 Depreciation and amortization expense 10000 18910 8910 Earnings before interest and taxes 34000 20090 13910 Interest Expense 4000 5604 1604 Earning before expense 30000 14486 11486 Income Taxes 9000 3986 5014 Net loss 10500 10500 Net income 10500 10500 0 Balance sheet Current Assets 118000 118000 0 Fixed Assets 82000 99820 4,498 Total Assets 200000 217820 17820 Current Liabilities 40000 48386 8386 Long-Term Liabilities 90000 59434 4498 Stockholder Equity 110000 110000 0 Total Liabilities & Equity 200000 217820 17820 Ratio Analysis The proportion investigation underneath should speak to the distinction in different proportions in the present connection and when the working leases are ordered to be decided Sheet after appropriation of the IFRS (Taguchi, 1986). ratio GAAP IFRS Current ratio 2.945 2.43 Quick ratio 1.65 1.39 Cash ratio 0.84 0.678 Debt ratio 0.451 0.501 From the above rations shows analysis of financial statement of the company after adoption of IFRS. Using the current ratio which shows the liquidity of the company using GAAPS the company is more favorable as it has higher ratio this also shows as per the GAAP the companies has a less debt burden resulting to less suffering of cash flow (Horton, 2010). In regard to quick ratio which also gauges the companies ratio, in which the inventory is excluded the company has higher liquidity meaning current assets can be easily be converted to cash compared use of IFRS. Using the cash ratio which shows similarly like above ratio shows that GAAP has a better cash ration compared to IFRS (Callao, 2007). Debt to capital ratio indicate the company’s capital structure on how it finances its activities in determining its financial strength this enable to differentiate from debt and equity financing. using the above analysis the company has weaker financial strength when financial statement are presented via IFRS this is because it has higher ratio hence an increase in companies default risk (Christensen, 2009). The ratio obviously demonstrate that IFRS has a more advantage as per result because it is more preservationist in regard to ratio results as for the present and long term lease decisions in comparison to GAAP according to the liquidity proportions are lower under IFRS and the distinctions are huge. Likewise, all long haul proportions are additionally more traditionalist when contrasted with GAAP. The suggestions here is that IFRS will have far more noteworthy negative ramifications on bond contract assertions and in addition other long and transient lender legitimately mandatory understandings than GAAP (Van Tendeloo, 2005). Conclusions on lease IFRS and US GAAP According to Ferrer, (2008) reporting is very essential in determining net worth of the company. Most investors use the financial statement to determine if to invest on a company or not. From the above results obtained in the analysis of ACE financial statement adoption of IFRS has an effect on the ratio by reducing liquidity and financial strength of the company. References PW Coopers.org International Financial Accounting Standards (IFRS). IAS numbers: 2, 3, 36, 37, 38, 39. Collins, Johnson, Financial Reporting and Analysis, (2004) 3rd Ed. Pearson, Prentice, Hall. White, Sondh (2008).The Analysis and Uses of Financial Statements, i, Fried, Wiley, 3rd Edition, U.S Generally Accepted Accounting Principles (US GAAP). ASC Numbers: 320, 330, 360, 410, 985. Callao, S., Jarne, J. I., & Laínez, J. A. (2007). Adoption of IFRS in Spain: Effect on the comparability and relevance of financial reporting. Journal of International Accounting, Auditing and Taxation, 16(2), 148-178. Christensen, H. B., Lee, E., & Walker, M. (2009). Do IFRS reconciliations convey information? The effect of debt contracting. Journal of Accounting Research, 47(5), 1167-1199. Van Tendeloo, B., & Vanstraelen, A. (2005). Earnings management under German GAAP versus IFRS. European Accounting Review, 14(1), 155-180. Horton, J., & Serafeim, G. (2006). Market response to and the value relevance of reconciliation adjustments from UK GAAP to IFRS GAAP: First evidence from the UK. Available at SSRN 923582. Ferrer, C., Callao, S., Jarne, J. I., & Laínez, J. A. (2008). The impact of IFRS on the European financial reporting. In Rotterdam, 31st Annual Congress of the European Accounting Association (Vol. 22, No. 4, pp. 2009-25). Taguchi, G. (1986). Introduction to quality engineering: designing quality into products and processes. Read More