Defaulting Capital Lease Allowances

1. According to the text, companies can actually acquire “property” rights by leasing assets. In a recessionary economy, purchase and lease defaults are rampant. In your opinion, what are the effects of defaulted capital leases to the lessor, lessee and economy as a whole? Should FASB consider rewriting capital lease allowances, even on a temporary basis, until the economy recovers? Give an example to support your opinion.
When companies default on a capital lease, the economy is hurt as a whole. Both the lessor and lessee are hurt financially. The lessor has to cover the extra expense of the property that should be generating income. The lessor also may have to spend more to get a new operation in the building. The lessee loses financial credit and cannot go out an borrow as easily if at all.
One of our contractors we were using to build got into a financial bind with one of their lessee’s a few months ago. The lessee went bankrupt and our contractor lost their main source of cash flow.
We were still paying the contractor unknowingly of all the financial binds they were in, after a few months the sub-contractors started placing liens on our building for unpaid work. All in all, we had to spend money on lawyers, paid sub-contractors to avoid liens and a default on our lease.

2. The FASB has strict reporting requirements for leases. If a lease qualifies as an operating lease, i.e., no property rights are acquired by the lessee, why are such specific reporting guidelines used? In light of the added expenses of obtaining such expenses (appraisal, presentation and disclosure, auditing expense, etc) is it fair to require these companies to adhere to such strict reporting requirements? Give an example of how a company may benefit or not benefit by complying with these requirements.
SFAS No. 13 was introduced to address how the revenue for leases should be recognized and any reporting should be done. FASB has given can only help companies with how to account for the expenses and gives companies a basis of how to report different types of leases. Operating leases do not have any affect on the balance sheet since they are treated as an operating expense unlike capital leases that show up as debt. It is completely fair for all companies to have to follow the same guidelines. For publicly traded companies, investors need to be sure they are comparing numbers the same for like companies. Investors need to have a clear picture of what is going on and companies have the potential to hide liability and misstate income if they are reporting improperly.
3. Inventory valuation is a major component of the presentation and disclosure of the 2008 financials of publicly traded companies. Many of these companies have plummeted financially. How might inventory valuation be used as a tool to make these companies seem more profitable to investors? Does decreased inventory valuation necessarily indicate low company profitability? Give an example to support your opinion
There are four types of inventory evaluation, but the main three used are first in first out (FIFO), last in first out (LIFO), and average cost.
The three methods are used but I believe the best to use would be FIFO method. This gives companies the most true statement of what the cost of goods were in a period. Following GAAP and reporting financial statements using the same inventory method help create strong financial opinion. Having a decrease in inventory doesn’t necessarily indicate low company profitability. It really depends on pricing and the economy at the time. For instance, with a pizza business, if they are paying $28 at the start of a period for a case of cheese and it bumps up to $32, the company could switch accounting methods LIFO to get the benefit of the lower priced cheese on the books and overstate income for a period. This would be misleading to investors and would look good on the financials but dishonest since it gives an inaccurate
cost.

4. Specific criteria separate operating leases from capital leases. When considering these criteria, companies need both internal and external expertise to determine how to characterize its leases. What are the consequences to the lessor and lessee if, during an audit, a lease that the company determined to be operating is actually a capital lease? Is it ethical for accountants to ignore this misclassification? If you were the auditor of a company with annual gross receipts of over $500,000, and you determined that a $2 thousand operating lease was actually a capital lease, what measures would you take? What if the lease was worth $2 million?

Accountants should follow GAAP and the standards it sets when reporting leases. For publically traded companies, auditors are expected to ensure that the company follows these standards; they certify this by signing the financial statements. The end users of the financials expect the items presented to be true and accurate and have been audited both by their accounting department and an outside source. Income may be misstated and the balance sheet is may be inaccurate. In the instance of the lease being classified wrong, I would reclassify the operating lease and make an adjustment to report it properly in the notes. I would not be worried so much as to income purposes unless the amount was worth the $2 million. There could have been a large amount of interest and other expense that could have been capitalized in the time the lease was being accounted for improperly. An adjustment would need take place on the more material items.