Question

Ballard Company rents a warehouse on a month-to-month basis for the storage of its excess inventory. The company periodically must rent space whenever its production greatly exceeds actual sales. For several years the company officials have discussed building their own storage facility, but this enthusiasm wavers when sales increase sufficiently to absorb the excess inventory. What is the nature of this type of lease arrangement, and what accounting treatment should be accorded it?

Name: Problem 4, Chapter 21: Intermediate Accounting
Uploaded: 2021-10-07T23:22:27-08:00
Duration: 2 min 28 s
Channel: Eric Mockensturm

   Ballard Company rents a warehouse on a month-to-month basis for the storage of its excess inventory. The company periodically must rent space whenever its production greatly exceeds actual sales. For several years the company officials have discussed building their own storage facility, but this enthusiasm wavers when sales increase sufficiently to absorb the excess inventory. What is the nature of this type of lease arrangement, and what accounting treatment should be accorded it?

Intermediate Accounting

Donald E. Kieso,… 13th Edition

Chapter 21, Problem 4

Instant Answer

Solved by Expert Eric Mockensturm

10/07/2021

Step 1

The nature of this type of lease arrangement is a short-term or operating lease, as Ballard Company rents the warehouse on a month-to-month basis and only when needed for excess inventory storage. Show more…

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Ballard Company rents a warehouse on a month-to-month basis for the storage of its excess inventory. The company periodically must rent space whenever its production greatly exceeds actual sales. For several years the company officials have discussed building their own storage facility, but this enthusiasm wavers when sales increase sufficiently to absorb the excess inventory. What is the nature of this type of lease arrangement, and what accounting treatment should be accorded it?

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Key Concepts

Operating Lease

An operating lease is a contractual agreement in which a company rents an asset for a short-term period without obtaining ownership rights. This type of lease is characterized by its flexibility and lack of long-term commitment, leading to the lease expense being recognized in the period incurred rather than capitalizing the asset. The arrangement typically does not involve transfer of risks and rewards of ownership, distinguishing it from a capital lease or finance lease.

Lease Accounting Treatment

Under operating lease accounting, the rental payments are expensed in the period they are incurred. The leased asset does not appear on the balance sheet, and no long-term liability is recognized. This treatment aligns with the principle of matching expenses with revenues and reflects the rental nature of the arrangement, where the asset is used temporarily without ownership.

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