Running head: RESPONSE TO CLIENT REQUEST RESPONSE TO CLIENT REQUEST ABRAHAM P. THOMAS UNIVERSITY OF PHOENIX RESPONSE TO CLIENT REQUEST This paper reflects the results of the research done on the lease and lease structures in the FASB codification as required by the supervisor in response to the request of a client. The client is a regional trucking company and currently owns 100 trailers which is 20 less than what is required to take up a new job that has been offered to the company.
Though the new opportunity promise growth, the uncertainty on the duration of the work is confusing and the client needs advice whether to buy or lease the extra trailers required to finish the job. The FASB codification throws light in to the different lease structures and the terms and conditions for lease transactions. The statement of financial accounting standards (SFAS) mentions about different lease structures. SFAS No. 13 has specified certain criteria by which lease structures are classified in to capital leases and operating leases.
The capital leases are the kinds in which the benefits and the risks are transferred to the lessee. The capital leases are further classified in to sales type leases and direct financing leases. According to Schroeder, Clark & Cathey, a lease is considered as a sales type lease when there is a manufacturer’s or dealer’s profit or loss which implies that the leased item is considered as an item of inventory and the seller or the lessor is earning a profit on that item (Schroeder, Clark & Cathey, 2005, p. 426). In case of a sales type lease, the fair value and the carrying value of the property would be different.
The risks and benefits in a sales type lease flows on to the lessee. A direct financing lease is the one in which the profit of the dealer or lessor is not recorded. As per the FASB codification, the recording of the total minimum lease payments are to be recorded as a receivable on the date of the transaction and the difference between that amount and the asset cost are to be treated as unearned income. Besides, as and when each rental payment is received, the receivable is to be reduced by the full amount of the payment, and a portion of the unearned income is to be transferred to earned income (FASB codification).
As per the SFAS No. 91, the initial direct cost in this type of leases should be matched in proportion to the recognition of the interest income because the direct financing lease is a revenue generating lease (FASB codification). The operating lease is the kind of lease in which the lessee is not responsible for the risk of ownership. The leased property remains as the asset of the lessor or the owner and lessee has only the right to use the property based on the terms of the lease agreement for a period of time as defined in the lease agreement.
Under this structure, rental payments are considered as revenue as and when they become receivable. According to the FASB codification, if rental payments are not made on a straight-line basis, rental expense shall be recognized on a straight-line basis unless another systematic and rational basis is more representative of the time pattern in which use benefit is derived from the leased property, in which case that basis shall be used (FASB codification).
The capital leases are reported in the balance sheet of the lessee at the cost of acquisition. The property is shown both as an asset and a liability on the balance sheet. In case of the operating lease, the rental payments are recorded as expense in the financial statements of the lessee and in most cases, the lessee is eligible for a tax deduction on the rental payments. According to Schroeder, Clark & Cathey, the use of leases can also have an impact on a company’s liquidity and profitability ratios.
The company employing operating leases to acquire its assets will have a relatively better working capital position and relatively higher current ratio and return on assets ratios than it would have if it had recorded the transaction as a capital lease (Schroeder, Clark & Cathey, 2005, p. 432). The regional trucking company would find the operating lease structure beneficial as the relationship with the customer is uncertain and but this lease equips the company with necessary trailers as long as the business requires those trailers.
While keeping the current businesses, the company can look for taking up new opportunities without bearing extra cost for additional trailers. In addition, company would be benefited by the option to write off the lease payments as expenses to get a tax deduction. Further, the company would be free of any risks attached with being the holder of the asset as the risk is born by the lessor but at the same time safeguards the trucking company from obsolescence. For any business, getting more clients or customers is prospective.
Keeping good relationship along with meeting all the requirements of the customers or clients is essential to sustain the business. As the regional trucking company is chosen by the new customer, the company has to prove its capability to meet the new customer’s requirements to be in business. The success of the company would lie not only in keeping the customer, but also in operating the business at the least possible liabilities. The option of operating lease would help the company to meet the requirements of the new customer and to offer a satisfactory service so that the business relation with the customer would last for long.