Ethics Case

You are the accountant for Sleezee Company. The Sleezee Company issued bonds with a 30 year life in 2015. These bonds have debt covenants that require Sleezee to maintain a debt to equity ratio of not greater than 2.0. The past couple of years have been challenging for Sleezee, with net losses being substantial resulting in a decrease in their Retained Earnings. While Sleezee has restructured its operations and developed a new product, net profitablility is not expected to occur again for a couple more years.

To bring the newly developed product into production, Sleezee needs to acquire new machinery. Acquiring the assets through signing a long term note is not possible because it would mean that their debt to equity ratio would then exceed 2.0, potentially making the bonds due immediately. The CEO has asked if it would be possible to lease the assets. Your boss, who is a CPA like you, tells the CEO that under normal circumstances, the answer to that is no. However, he has an idea of how to avoid the capital lease requirements, to structure the lease so that it is accounted for as an operating lease. The equipment Sleezee needs to lease has a 5 year life. Your boss proposes that we work with the leasing company and set the lease up as a 2 year lease. This would allow Sleezee to account for the lease as an operating lease. In addition, Sleezee would tell the leasing company (the lessor) that they would release the equipment for another two years after the first two year lease is over, unofficially guaranteeing a second lease. As your boss points out, if we go back on our word to the lessor and do not sign a second lease, we could not find this equipment anywhere else and the lessor would no longer lease any assets to us.

You go back to your office troubled by this proposal. You know that legally, this proposal is acceptable. But you also understand that the economic substance of the transactions make it a capital lease. You decide to write a memo to your boss about this issue, citing the CPA Professional Code of Conduct for support.

Required: Write a memo to your boss explaining why you believe their proposal is or is not ethical from the standpoint of a CPA. You must integrate two ethical codes of conduct into your memo, not just citing them, but explaining how they support your position. Second, you must then give both a positive and a negative for the position that you support.