Mallard Company Rents Warehouse Month To Month
Mallard Company Rents A Warehouse On A Month To Month Basis For The St
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? Please use 2 APA citation.
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The arrangement described by Mallard Company, where the company rents a warehouse on a month-to-month basis to store excess inventory, is characteristic of a short-term, cancelable lease agreement. This type of lease is typically considered an operational lease under accounting standards such as the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 842, which governs lease accounting (FASB, 2016).
An operational lease involves an agreement where the lessee (Mallard) rents the asset for an agreed period, often short-term, with the right to terminate the lease relatively easily. This contrasts with a finance lease, which effectively transfers most risks and rewards of ownership to the lessee. The key features of an operational lease include its short duration, flexibility, and lack of ownership transfer at the end of the lease term (American Institute of CPAs, 2021).
In the case of Mallard’s month-to-month arrangement, the lease is inherently flexible, allowing the company to adjust storage space based on its fluctuating inventory needs. From an accounting standpoint, such leases should be reported on the lessee’s balance sheet as a right-of-use asset and a lease liability, if they meet the criteria outlined in ASC 842 (FASB, 2016). However, short-term leases—those with a lease term of 12 months or less and no purchase option—can be exempted from recognition, with lease payments recognized on a straight-line basis over the lease term (FASB, 2016).
Given the temporary and flexible nature of Mallard’s lease, the company could elect to apply the short-term lease exemption, which allows recognizing lease payments as an expense on a straight-line basis over the lease period, without recording a right-of-use asset or liability. This approach significantly simplifies accounting and reflects the lease's short-term, operational nature. On the other hand, if the company chooses to recognize the lease as a right-of-use asset and liability, it must estimate and measure these amounts at lease commencement, which may be less practical given the variability inherent in month-to-month arrangements.
In my view, the most appropriate accounting treatment depends on the company's internal policies and the specifics of each lease. For truly short-term, flexible arrangements like Mallard’s, applying the short-term lease exemption aligns well with the economic substance of the transaction, which is primarily an operational expense rather than a capitalized asset. This approach provides users of financial statements with relevant and reliable information about the company’s leasing activities without overstating assets and liabilities that are inherently temporary and non-capitalizable.
In conclusion, the month-to-month warehouse rental arrangement of Mallard Company qualifies as an operational lease. The preferred accounting treatment would be to qualify for the short-term lease exemption under ASC 842, recognizing lease payments as expenses when incurred, reflecting the temporary, flexible, and operational nature of these agreements. This approach ensures that the financial statements accurately portray the company's leasing activities in accordance with current standards while maintaining simplicity in accounting.
References
American Institute of CPAs. (2021). Audit and Accounting Guide: Leases. Retrieved from https://www.aicpa.org
FASB. (2016). Accounting Standards Codification (ASC) Topic 842 – Leases. Financial Accounting Standards Board. Retrieved from https://asc.fasb.org