Report Example on Operating and Capital Leases

A. What are the differences between operating and capital leases?

Operating lease refers to the transfer of only rights to use of the property to the lessee. During the lease period the lessee does not assume the risk of ownership and therefore the lease is treated, as an operating expense thus it does not affect the balance sheet. The capital lease, on the other hand, involves the transfer of all benefits and ownership risks to the lessee. A capital lease is treated like a loan and its interest as operational expenses. The leased asset is included as an asset on the balance sheet while the outstanding loan is treated as a liability.

Another difference between the two is that, with an operating lease, the lessee does cater for the asset depreciation but in the capital lease the lessee is treated as an owner and therefore is required to claim annual asset depreciation ("Operating versus Capital Leases", 2017)

B. Describe the particular leases of your company based on the liability section of your companys balance sheet.

Server /storage lease as at 2016 Amazon companys balance sheet shows that it had about $2bn worth of servers lease debts. In other terms, the company has invested this amount of money to lease the servers rather than purchasing them. This lease is booked in the balance sheet as other long-term liability and classified for lease payment obligations. The current liability associated with the leased capital is classified under the current liabilities of the balance sheet but Amazon, unlike others like Wal-Mart does not give the break down (Shady, 2017).

C. What impact has the leases had on the companys financial statements for the most recent year?

Amazons capital lease obligations (CLOs) has been on the rise since 2010, however, the company not been giving a full breakdown of these leases, an action that has led to the rosier look of the free cash flow than it is in reality. 2014, the first time they broke out its principal repayments of CLOs, it was revealed that company had been treating these repayments as ordinary capital expenditure where in reality, this amount was just a mere $500. This makes Amazons financial statements inflate the free cash flow and ROI beyond what is presented to the investors (Spaid, 2017).

D. Discuss the advantages and disadvantages of leasing a building versus purchasing one.

Advantages

Leasing eliminates the down payment cost that in return increases the free cash flow available for the business.

Lease payments are treated as business expenses and therefore reduce the amount of taxable income of the business.

When one leases a building, the lessor caters for the cost of maintenance and repairs and this significantly reduces the expenses and time required to carry out these activities.

Leasing opportunities are readily available compared to those for sale hence reducing the time required to acquire a business premise.

Disadvantages.

Most of the lease costs increase after the lease period is expired. This causes extra costs for continuing businesses.

With a leased building, there is no growth of in value of the building hence the capital growth does not benefit the company.

Leasing delimits the control over the premise and this means one cannot improve it as they wish.

VI. Statement of Changes in Financial Position

E. From the perspective of an investor, determine whether or not you would invest in your chosen company based on the companys statement of changes in financial position (SCFP). Support your opinion.

The best way is to determine Amazons status of the SCFP key parameters.

Current assets the current assets of a company is the major concern for an investor because it determines its ability to remain afloat amidst of negative markets waves, as well as, the ability to grow in future. The annual income statements of the last 4 years show an upward trend in the growth of current asset with 2016 showing a 28.2% increase from the previous year.

Liabilities a companys liabilities especially the current liabilities are an indicator of its financial health. It provides a means to compute the current ratio, which determines the companys ability to settle debts. For the last 4 years, Amazon has been experiencing growth in the total liabilities at an average rate of 17%. However, a critical analysis of the current ratio shows an average of 1.0 per year for the last 5 years, which is a good liquidity status.

Stockholders equity the changes in equity components such as the annual retained earnings are important to the investors because they represent the companys net worth. For Amazon, the total equity has been on the upward trajectory at an average 41% per year, showing that an investment in the company will increase in value.

From the above SCFP analysis, Amazon Inc. present financial health is okay and from the trends over the past 4 years, the key indicators show an upward positive trend. This shows it safe to invest in Amazon Inc.

F. Review the companys SCFP for any concerns that may need to be addressed. As controller of your company, prepare a memo to your CEO, giving a summary report for possible recommendations.

Memo

To: Finance Department

From: CEO, AMAZON INC.

CC. All Departmental Heads

Date: 11/10/2017

Subject: Findings and Recommendations of SCFP Analysis

The only major issue identified in the analysis of Amazons SCFP is the cash liquidity. Upon critical analysis of the current ratio over the last 4 years, it has been discovered that ratio keeps moving up and down showing instabilities regarding the current assets and current liabilities. The importance of liquidity to the company cannot be overemphasized hence there is need to address the issue urgently. To address this, I recommend the following;An urgent review of the accounts receivable -It has been noted that the accounts receivable have been continuously accounting for over 18% of the total current assets each year. There is a need to restructure the credit period to make it short.

Review the shareholders funds- Increasing the contribution of the shareholders funds, will pool more cash into the current assets and consequently stabilize the current ratio.

References

Shady, S. (2017). Understanding How Amazon's Use Of Capital Leases Overstates Its Cash Flow Metrics. Seeking Alpha. Retrieved 10 October 2017, from https://seekingalpha.com/article/2743335-understanding-how-amazons-use-of-capital-leases-overstates-its-cash-flow-metrics?page=2

Spaid, J. (2017). Amazon Is Actually Worth a Lot Less Than You Think and Here's the Very Complicated Explanation. TheStreet. Retrieved 10 October 2017, from https://www.thestreet.com/story/13311239/1/amazon-is-actually-worth-a-lot-less-than-you-think-and-here-s-the-very-complicated-explanation.html

Operating versus Capital Leases. (2017). Pages.stern.nyu.edu. Retrieved 10 October 2017, from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/lease.htm