USA How do I Classify Rent-To-Own cost of goods?

[Kee]

I have a Rent-To-Own business. The max duration of the lease is 1 year, which at the end, the customer will own the item.

I researched some other companies, and instead of the recognizing the cost of rented merchandise as "Cost of Goods Sold", they record it as an asset. That makes sense since the ownership of the item does not transfer to the buyer until the lease is fully paid. If this is the case, should it be a fixed asset, or a current asset?

Additionally, these other companies depreciate the assets (straight line), and reclassify the monthly depreciation amount to "Cost of Lease Revenue." This makes sense to me, as well.

What do you think?

 

[smallbushelp]

I've never worked with your type of business but GAAP would support the asset classification as fixed asset because a company doesn't normally depreciate current assets. And even though the lease term is one year, is it possible for the renter to cancel the agreement before the end? If so, then the item could conceivably be in your inventory for more than a year, thus not a current asset.

And yes, you will depreciate the item over it's useful life, but I'm not familiar with the reclassification of depreciation to "cost of lease revenue." Is that an expense account? To me, depreciation is depreciation and I would account for it as such. You'll need to keep track of it for tax purposes anyway. "Cost of lease revenue" sounds like interest or something else. Personally, I wouldn't use it. I would be interested to hear from other accountants regarding that one.

 

[Kee]

Thank you for the response. That is very helpful to me. Regarding the "cost of lease revenue", I pulled that from an SEC filing summary of another Rent-to-own company. I think I may have misunderstood. Below is the link, and the portion I pulled that from is underlined. I think you are right. I just depreciate the cost of the leased item. I'm not sure what they mean by "corresponding charge to cost of lease revenue". I took that to mean a reclassification of the depreciation amount. Am I wrong in that assumption?

http://biz.yahoo.com/e/150331/fpay10-k.html

Lease Merchandise - Until all payment obligations required for ownership are satisfied under the lease agreement, FlexShopper maintains ownership of the lease merchandise. Lease merchandise consists primarily of residential furniture, consumer electronics, computers, appliances and household accessories and is recorded at cost. FlexShopper depreciates leased merchandise using the straight line method over the applicable agreement period for a consumer to acquire ownership generally twelve months with no salvage value. When indicators of impairment exist FlexShopper accelerates depreciation to six months from the lease origination date and records an impairment reserve against the carrying value of the leased merchandise with a corresponding charge to cost of lease revenue for the excess of the depreciation over the applicable agreement period. Principal impairment indicators are leases with more than eight payments past due, where collection access is denied or problematic indicating the Company may need to attempt to repossess the items. FlexShopper is developing historical charge off information to assess recoverability and estimate of the impairment reserve. See "Note 2" in the Notes to Consolidated Financial Statements included under "Item 8."

 

[kirby]

Time to read FASB 13, guys.

First of all - FASB 13 is going to take that contract which transfers ownership at the end of the lease and call this a DIRECT FINANCING LEASE on the lessor's part, per its lease criteria tests. This animal has RENTS and usually (but not in this case) a RESIDUAL. Point is - the FASB 13 accounting does NOT record a fixed asset for a direct financing lease. There is NO fixed asset for books and thus NO book depreciation.

 

[smallbushelp]

I disagree that FASB 13 comes into play in this case. I believe the rent to own business is a totally different animal and is not governed by FASB 13. The lessee in this situation is not a company concerned about expenses or depreciation or recording a capital lease or an operating lease and that's what FASB 13 is all about.

And also, granted, I haven't dealt with direct financing leases in a while, but if memory serves, the lessor in a direct financing lease owns the asset and, therefore, may depreciate it. I'll do some reading over the weekend.

 

[kirby]

Well smallbushelp, looking at the posts above you guys are calling this a lease. So now you say its not, cause for some unclear reason FASB 13 does not apply? So, then .....what is it?

 

[Triest123]

I have a Rent-To-Own business. The max duration of the lease is 1 year, which at the end, the customer will own the item.
What do you think?

It is classified as "sale under finance lease" as the customer will own the goods at the end of the lease period.

Suppose the selling price of the goods is $100,000 and the costs of the goods is $60,000. You allow your customer to make 12 months intalments and the effective interest rate you charge to your customer is 6% p.a.

The monthly instalment made by your customer would be $8,606.64 and the total interest you received for 12 months is $3,279.72
(*You should prepare the monthly schedule for the account receivable under finance lease)

The accounting entries are

(i) Dr Account receivable under finance lease 100,000
Cr Sales 100,000
(ii) Dr Cost of goods sold 60,000
Cr Inventory 60,000
(To record the sale of goods under finance lease)


Dr Bank (8,606.64 x 12 months) 103,279.72
Cr Account receivable under finance lease 100,000.00
Cr Interest income 3,279.72
(To record the total money received and interest income at the end of the finance lease)

Note :
1. Account receivable under finance lease is a 'Financial Asset' and should be recorded at "amortised costs". (i.e. the principal and the interest should be split off from the payment received from the customer over the finance lease period)

2. The monthly schedule for the lease receivable must be based on the effective interest rate.

3. To the lessor (i.e. the seller), the goods sold under finance lease should not be recognised as "leased asset" and thus no depreciaton has to be provided. It, in fact, views as normal sale of goods practice.

 

[kirby]

I agree Triest123. For your example, in FASB 13 terms, the above is a Sales Type lease.And the key here is - there is no fixed asset entry.

 

[smallbushelp]

Kirby, both you and Triest123 are basing your statements on FASB 13. I still say that FASB 13 does not apply in a rent to own business. According to Accounting Standards Codification 840-10-15-2 (which replaces all of the FASBs), “The guidance in the Leases Topic applies to all entities.” I’m assuming that Kee’s business deals with consumer goods. In that case, his customer is most likely not an entity. Therefore, in my opinion, those accounting rules that you are describing would not apply. Do either of you work with companies in this industry? I would be interested to hear from an accountant who does.

Also, statements were made that the items being rented would not be recognized as assets and therefore, no depreciation expense is recognized. However, IRS Publication 946, Chapter 4, specifically deals with qualified rent to own property in accordance with IRC Section 168(e)(3)(A)(iii). We’ll have to find out more specifics about Kee’s business but I think he would be classified as “rent-to-own contract” which classifies his “inventory” (for lack of a better word) as 3-year property and depreciable.

 

[kirby]

Hi smallbushelp.

The language you cite "applies to all entities" as excluding the lessee's customers does not have the meaning you ascribe to it. It means that this guidance applies to everyone. i.e - There is no type of industry that is excluded. In any case, the point is moot because here we are interested in Kee's financials and not those of his customer.

So let's go to the ASC itself. the definition of what is a lease fits Kee's transaction perfectly. I see above you disagree, but then what do you propose that this is? You have never offered an alternative.

As far as depreciation, you bring up the tax code as proving the lessor has an asset to depreciate. But that is TAX accounting. Note above I specifically said there is no fixed asset FOR BOOKS. We are discussing the BOOK (financial ) accounting, not the tax treatment. And again - there is no fixed asset recorded in this type of lease for BOOK accounting.