Mallard 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 executives have discussed building their own storage facility, but this enthusiasm wavers when sales increase sufficiently to absorb excess inventory.
What is the nature of this type of lease arrangement, and what accounting treatment should be accorded it, in your view?
Mallard Company rents a warehouse on a month-to-month basis for the storage of its excess inventory, this type of lease arrangement is in the nature of Operating Lease because this lease is for short term duration and rents on requirement basis.
In case of operating Lease term of the lease will be for short term as compared to the useful life of assets being leased and does not involve the transfer of risk and reward of ownership of assets. An operating lease is commonly used to acquire equipment or assets on a relatively short-term basis and the lessee does not have an option to acquire the assets at the nominal value at end of the lease term.
The lessor records the assets under operating lease as a Fixed assets in its books and depreciates the assets over its useful life and lease rental recognize as operating Income.
In case of Lessee-
Unlike the capital lease, the operating lease does not result in recognition of an asset and liability in the balance sheet of the lessee. Operating lease expense is recognized in the books of the lessee on a uniform basis even if the relevant lease rentals are not uniform.