In June 1988, British & Commonwealth PLC (B&C) acquired Atlantic Computers, the world’s third largest computer-leasing company. In April 1990, B&C placed Atlantic Computers into administrative receivership and wrote off its $900 million investment in the company. The reason for the write-off? Atlantic’s method of accounting for leases.
Atlantic had developed what was called a “flexlease,” which allowed customers to upgrade their computers at specified points during the lease period. The flexlease involved two separate contracts, one with a financing institution and the other with Atlantic. When customers elected to exercise their flex options, Atlantic would take back the equipment, pay off the remainder of the contract to the lender, and sell the equipment in the used computer market.
Even though the original lease arrangement did not meet the criteria for a sales-type lease, Atlantic was estimating the profits to be made from the sale of those computers that would be returned, assuming customers exercised their flex options, and was recognizing these sales profits when the original lease contract was signed.
1. Is there anything wrong with Atlantic’s method of accounting for the profits to be made on the “flexleases”?
2. When would be the most appropriate time for Atlantic to recognize profits from the sale of a computer that was returned under a flex option?
3. Why would British & Commonwealth PLC get rid of Atlantic rather than simply change the accounting practice?