Lease has been categorized into capital (financial) and operation lease. Funds lease or rent bears an asset and a matching burden at the current value. The value is at the minimum lease payments. Minimum lease payment refer to the rental payment made during the period of the lease in addition to bargain value or any penalties as a result of non renewal of the lease by the end of the contract(Nailor & Lennard 2009, p. 43).
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Capital asset assigned a depreciating factor over time the same as the other assets. The liability is reduced as the lease payments are made. Operating leases attract rental payments, which are paid simply as expenses.
Bookkeeping for capital lease engages the “lessee accounting for them as if assets or capital leased were obtained on monthly rental payments and the payments were based on a principal and interest on the principal” (Nailor & Lennard 2009, p. 44). Once payments are carried out every month, the liability or burden reduces and in that respect price of the asset is devalues with the devaluing factor. By the end of the contract, the liability is zero and the lessee has to renew the contract.
Budgeting looks at the scoring whereas accounting can be looked at as the statements that are captured financially and they give the reflecting of the status of the assets in the organization. This is an important component for any organization as they play role in informing decision making especially when looking at any changes in the lease agreement aimed at circumventing any future possible scoring opportunities.
In this situation we see the capital lease taken into account instead of operating lease which may not be representative in such situation and may not give an appropriate picture at this phase of the discussion and decision making process. In most scenarios the lease applied, the reporting of the organization or company assets has to be changed in the financial statement (McGregor 2006, p. 34).
In instances where the lease is considered as an operating or working lease; all the payments made every moth will be considered as the leasing operating expense and used in the course subtracting income tax. Consequently, no acknowledgment of capital or financial burden in such situations.
However, there has been confusion on when to treat leases as capital or operating. As a result, the International Accounting Standard Board (IASB) has developed a discussion paper to propose abandon the boundaries between the finance and operating and instead treat them as contractual asset and the use right of the lease. The proposal is that all leases would be treated to give rise to an asset and a liability and then depreciated as owned tangible assets.
The objective of joining the two types of leases is because all leases are viewed as having similar economic substance. A lessee has right to using a leased property for his or her own benefits hence the property can be referred to as an asset. The lessee has an obligation to pay monthly rentals to the lessor and hence the property can be referred to as a liability. At this point, the leased property should be treated as an asset the lessor but at the same time as a liability to the lessee.
Change of the way people do business has always called for different ways of accounting for the business operations. Competition among different market operators require a more clear financial approach that can that passes a message to both the management and the sub ordinates as well as the shareholders.
Participatory management is the most current way of doing business for two minds are better than one. For the all stakeholders to be consulted and be able to give any meaningful contributions then they must start by understanding the mission and vision of the company, its current and expected financial status. This can only be possible with clear, short and simplified records. The simplification should not replace accuracy and relevance but should enhance instead.
Advantages of treating the capital and operating leases the same
Having the basic understanding, the leases have the same basic economic meaning makes it easier. By treating the leases, the same makes the accounting technicalities easier. This way a more accurate and straightforward financial report can be presented by the accounting team by the end of the expected time period. In addition of being easy to develop the financial report using the new proposed approach, it is time saving in the sense it is easy to work on report hence takes less of the accountants time.
The reports are also easy to be understood by the managers and the company shareholders. The financial reports have been is that, they are technical and more formal. The accounting jargon can only make sense to the experts. The case should not be as it is currently. The new proposed approach will ensure that all are catered for in the analysis and use of the company’s financial reports. Communication between the experts and the stake and shareholders will be enhanced and no one will feel left out of the main decisions of the company. Shareholders always have the greatest interest in the financial status of the company for they are the owners. Any reason of not exactly knowing the status of the finances in the organization will demoralize them from further investments.
The cost of developing the accounts and the audit reports will cost less. Those expertise hired to develop the reports will ask for lesser money for the lesser job. For the case of easy jet limited, pricewaterhousecoopers would get a smaller remuneration. The cost of training new personnel especially will also be cheap in the sense that the content and processes they need to understand is are straightforward.
This approach by the International Accounting Standard Board will also ensure that the records give a true picture of the company. Long and complex reports are always faced with the challenge of errors. Reports with accounting errors do not give a true reflection of the company.
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The consequence may include wrong decisions. For instance, wrong accounts can imply a strong financial status and forecast a growth in the financial strength hence prompting the managers to expanding their products of the business when in the real situation the company is being faced with diseconomies of scale. The proposed approach will ensure that the records are shot and precise and as a result, the decision reached will rational and the best for the growth and survival of the company.
The usability of any report is determined by the degree to which the report is understandable to target audience and the degree to which they can adopt it. Easy and clear reports with clear and realistic recommendations are easy to adopt and execute than complex reports with complex recommendations, which no one understands apart from the professional who in most cases are not the implementers.
The top managers together with the subordinate staff should be in a position to understand the report together with the accompanying recommendations even if it’s with some guidance from the experts and be in a position to implement the report for a better future company.
Disadvantages of treating the capital and the operating leases the same
Some vital information can be lost during the time of considering the two categories of leases as the same. Losing such information may result to the reports giving a wrong picture of the organization. Accounting reports are always important in determining what course of action to take. Wrong decisions are likely with the wrong accounting and audit reports. This new approach may turn the way of doing business.
Almost all forms of businesses needs and requires so some accounting to be able to establish their financial performance. To give a true picture of the financial status, the accounting reports need to give a clear picture of the organization. One of the ways of ensuring that the true picture f the company is gotten is by breaking the operations of the business in smaller units, which are clear and manageable.
For instance, financial lease may be doing well while at the same time operative lease is doing poorly. These need to come out in the financial record. On merging the way the two types of leases are treated, such a trend may be lost in calculations and making managers think that all is well. This will also help in identifying and fixing the problem (Easyjet plc 2009).
Implication of the approach on the accounting report of easy jet limited
Assets are always considered before the liabilities on the determination of the company’s revenues and net-worth. This approach will increase the asset worthiness of the company. The value of the lease will be added to the other tangible assets (Easy jet 2009, p. 23). What needs to be remembered is that the assets need to be depreciated at a rate comparable to the other assets owned by the company.
On the part of the monthly payment, it will be treated as a liability and subtracted together with the other tangible liabilities. This will have a negative implication on the noteworthiness of the company records.
The biggest challenge is to ensure that the accountant apportions correctly the values of the assets and the liability to avoid over valuing or undervaluing or overcharging the depreciation.
On my opinion the advantages of the new proposed approach to accounting for the operating and financial leases out do the disadvantages in terms of time saving, cost cutting usability and the ease with which the report can be adopted and implemented. As a result, the approach should be adopted by the company.
However, the adoption should not be wholesale for different companies face different working conditions but it should be piloted with a comparative analysis of how it compares with the old way of accounting for the financial and operating leases. Once it is established that the new approach gives reliable results, and then it can replace the older one other than adopting it wholesale only to find out that it is not an appropriate approach for easy-jet Company.
Easyjet plc, 2009,’ Annual report and accounts,’ About Easyjet. Web.
McGregor, W 2006, ‘Accounting for Leases: A New Approach, Recognition by Lessees of Assets and Liabilities Arising Under Lease Contracts,’ Financial Accounting Foundation Journal, Vol.2, No. 163, pp. 43.
Nailor, H & Lennard, A 2008,’ Leases Implementation of a New Approach,’ Financial Accounting Foundation Journal, Vol. 2, No. 206, pp. 43-45.