C&C Trucking Company

MEMORANDUM

TO: Supervisor

FROM: Auditors

DATE: September 5, 2011

SUBJECT: Leases and Lease Structure

This memo is a follow-up to the conversation we had about the new business opportunity for C&C Trucking Company and a potential new customer. I have outlined briefly below the different types of leases that are defined by the Financial Accounting Standards Board (FASB), changes to lease standards that may come into effect and a recommendation of how our client can capitalize on this potential deal with the customer.

It is important to understand the two types of leases that the FASB defines; the operating lease and a capital lease. A capital lease is a little more complicated than an operating lease because to consider a lease as capital, the lease must meet multiple qualifications. According to the ASC 840 (FASB, 2009) (IAS 17), if a lease meets at least one of four criteria listed below, the lessee, and the lessor must report the lease as capital versus an operating lease.

Capital lease criteria:

1. Does the lease transfers ownership to the lessee before the end of the lease term?

2. Does the lessee receive a bargain purchase price of the leased property?

3. Does the lease lasts 75% or more of the time the property is useful?

4. Does the minimum lease payment exceed 90% of the fair market value?

ASC 840 (FASB, 2009) identifies two additional criteria the lessor must evaluate to decide what type of capital lease he or she is entering into. A direct financing lease or sales type lease are two options. A sales type lease meets one of the criteria listed above, both of the qualifications listed below, and have dealer or manufacture profits or losses. A direct financing lease has the same requirements as sales lease, except the lessor does not have dealer profit. The lessor is essentially financing the asset to the lessee through a lease agreement instead of selling the item to the lessee directly.

Sales versus direct financing...