Chapter 15, Problem 15.5DMP

Communication Case 15–5

Where’s the gain?

Appendix

General Tools is seeking ways to maintain and improve cash balances. As company controller, you have proposed the sale and leaseback of much of the company’s equipment. As seller-lessee, General Tools would retain the right to essentially all of the remaining use of the equipment. The term of the lease would be six years.

You previously convinced your CFO of the cash flow benefits of the arrangement, but now he doesn’t understand the way you will account for the transaction. “I really had counted on that gain on the sale portion of the transaction to bolster this period’s earnings. What gives?” he wondered. “Put it in a memo, will you? I’m having trouble following what you’re saying to me.”

Required:

Write a memo to your CFO. Include discussion of each of these points:

1. How the transaction should be accounted for.

2. Why General Tools will not get the gain the CFO had counted on.