Leases and Lease Option Memo
Memorandum To: Supervisor From: Date: March 14, 2011 Re: Leases and Lease Issues
CONFIDENTIAL The trucking company currently owns 100 trailers and a new client have requested 20 more for a total of 120 trailers for its project. The relationship with the new client is uncertain but at the same time it has potential for significant growth of the company. The uncertainty of the relationship may have an effect on the financial position of the client company. The additional trailers may be obtained by the trucking company through either a lease option or by direct financing. If the trucking company is considering leasing the additional trailers to provide to their new client they must first understand leases and lease issues according to the Financial Accounting Standards Board (FASB). FASB Statement No. 13 establishes standards of financial accounting and reporting for leases by lessees and lessors. The leases outlined in FASB Statement No. 13 are operating leases, sales-type leases, and direct financing leases. Sales-type leases and direct financing leases are capital leases and must meet specified criteria; if not, it is an operating lease. Operating leases are accounted for like rental property. Sales-type and direct financing leases, meeting the criteria of a capital lease and two additional criteria dealing with future uncertainties, are accounted for as an investment. A brief description of each lease type below. Operating Leases An operating lease is a lease in which the trucking company would collect rent and the new client uses the trucks ( leased asset) in exchange for rent payments to the trucking company. The new client only uses the asset; there is no transfer of ownership or any risk or benefit of ownership. Under an operating lease the new client will record payments made to the trucking company as a Lease Rent Expense and the trucking company will record the rent payments received has Rental
CONFIDENTIAL The trucking company currently owns 100 trailers and a new client have requested 20 more for a total of 120 trailers for its project. The relationship with the new client is uncertain but at the same time it has potential for significant growth of the company. The uncertainty of the relationship may have an effect on the financial position of the client company. The additional trailers may be obtained by the trucking company through either a lease option or by direct financing. If the trucking company is considering leasing the additional trailers to provide to their new client they must first understand leases and lease issues according to the Financial Accounting Standards Board (FASB). FASB Statement No. 13 establishes standards of financial accounting and reporting for leases by lessees and lessors. The leases outlined in FASB Statement No. 13 are operating leases, sales-type leases, and direct financing leases. Sales-type leases and direct financing leases are capital leases and must meet specified criteria; if not, it is an operating lease. Operating leases are accounted for like rental property. Sales-type and direct financing leases, meeting the criteria of a capital lease and two additional criteria dealing with future uncertainties, are accounted for as an investment. A brief description of each lease type below. Operating Leases An operating lease is a lease in which the trucking company would collect rent and the new client uses the trucks ( leased asset) in exchange for rent payments to the trucking company. The new client only uses the asset; there is no transfer of ownership or any risk or benefit of ownership. Under an operating lease the new client will record payments made to the trucking company as a Lease Rent Expense and the trucking company will record the rent payments received has Rental
References: Lee, S.S.K. (2003). Federal Accounting Standards Advisory Board. Retrieved March 14, 2011, from http://www.fasab.gov/pdffiles/combinedleasev4.pdf .