Short on cash, Smith Corp. enters into a contract with Jones Corp. to sell a building used in its operations and then enters into an agreement with Jones to lease back the building from Jones, thereby enabling Smith continued use of the building. Theseller-lesseeevaluates the sale under Paragraphs606-10-25-1through606-10-25-8, and Paragraph606-10-25-30, and determines that the transaction qualifies as a sale under Topic 606. Next, based on the information in the table "Smith-JonesSale and Lease Terms," theseller-lesseeevaluates the lease classification criteria in Paragraph842-10-25-2. There is no transfer of ownership; that is, ownership will vest with thebuyer-lessorafter the transfer, and there are no purchase or renewal options available to theseller-lessee. The lease term is only 33% of the building's remaining economic useful life; the present value of the lease payments is $12,289,134 $20,000,000, which is a little more than 61% of the fair value of the asset; and the asset is not of a specialized nature. Since none of the criteria from Paragraph842-10-25-2are met, theseller-lesseewould classify the lease as operating, thereby allowing the transaction to qualify as a sale and leaseback.

On Dec. 31, 2021, theseller-lesseewould record the transaction as shown in the table "Journal Entry Based on Amortization Table."

Theseller-lesseewould make similar entries for the remaining nine years. Next, assume the contract provided Smith Corp. with an option to purchase the building on Jan. 1, 2026, for $12,000,000 and that the assets similar to the subject asset are not readily available in the market. In this case, the transaction would not still qualify as a successful sale and leaseback.

Smith Corp.'s option to purchase the building at the end of year 5 precludes treating the transfer of the asset as a sale under Paragraph842-40-25-3(assuming the narrow exception provided by subparagraphs a and b are not met). In this case, the transaction does not qualify as a sale and leaseback, and must instead be treated as a financing pursuant to Paragraph842-40-25-4. This treatment results in the recognition of a financial liability of theseller-lessee. Further, theseller-lesseemay not derecognize the asset and must continue to record depreciation expense on thebuilding.

Under this circumstance, Paragraph842-40-30-6brequires that the book value of the asset cannot exceed the carrying value of the liability at the earlier of the lease termination date or the date at which control over the asset is transferred to thebuyer-lessor. Here, theseller-lesseemust determine an interest rate that will equate the carrying value of the financial liability to the carrying value of the building at the exercise date of the option. Based on the above fact pattern, that date would coincide with Dec. 31, 2025. At this date, the book value of the building would be $18,000,000 ($600,0005) = $15,000,000. The imputed rate would be calculated using the figures in the table "Factors for Calculating Imputed Rate."

In connection with this financing, Smith Corp. would record the transaction as shown in the table "Journal Entries Related to Failed Leaseback 20212025."

Assume that Smith Corp. does not exercise the option. The leasing arrangement now qualifies for classification as an operating lease and treatment as a leaseback. In this instance, Smith Corp. would eliminate the carrying value of the buildingandfinance liability. In essence, such elimination would be equivalent to a sale, as theseller-lesseehas effectively transferred control of the underlying asset (i.e., the building) to thebuyer-lessor. Theseller-lesseewould also record aright-of-useasset and related lease liability equal to the present value of the remaining lease payments (20262030). On Jan. 1, 2026, theseller-lesseewould make the entries shown in the table "Option to Purchase Not Exercised: Successful Leaseback Established at End of 2025."

2. Explain to what extent the corporation's shareholders might feel the corporation breached any measures of an entity of the highest ethical standards.
4. Explain to what extent the corporation's board of directors might ever feel that management breached any measures of an entity of the highest ethical standards.
6. Use at least two of the ethical viewpoints as presented inethical approachesto provide the ethical reasoning to address your company's use of off-balance sheet accounting and managements profiting from the arrangement. 

Answer rating: 100% (QA)

From an ethical standpoint shareholders may feel that the corporation breached transparency and accountability measures by engaging in offbalance shee... View the full answer