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?

Short answer

The lease should be reported as an operating lease.

Step-by-step solution

Meaning of Lease Agreement

A lease arrangement refers to a lease contract recognizing a similar arrangement for a specified period in which the lessee is expected to pay the lessor, in whole or in part, for the use of the lease for a specified period.

Explaining the nature and the accounting treatment of the lease agreement.

Ballard Company's intermittent and short-term storage space leasing is rarely viewed as an asset purchase or even a finance arrangement. The contract is mostly made up of services that will be performed proportionately by the lessor, and the lessee's rent will be offset by the lessor's service.

Although it is possible to argue that certain property rights have been acquired, the accounting treatment would be to record only periodic rental payments as they are made and to allocate rent expenditures to the periods in which the benefits are received.

The lessor's services are above the rents paid. In other words, the rent payment is past due, so no asset will be capitalized, and no liability for lease payments will be recorded. This is an operating lease.