(Financial reporting classification of resource inflows to General Fund)

Attica Prison, located in upstate New York, was built in 1931, was fully paid for many years ago, and is still being used today. During the 1990s, however, the state developed a scheme to raise resources by selling and leasing back the prison. The state used one of its public authorities, the Urban Development Corporation (UDC), to accomplish the financing arrangement. (One newspaper reporter noted that using the UDC was somewhat ironic because the UDC had been created originally to facilitate the development of affordable housing for low-income persons.)

This is how the scheme worked. The state sold the prison to the UDC for $200 million, under an arrangement whereby the state leased the prison back from the UDC for 30 years. The state deposited the cash in its General Fund. The UDC got the cash by selling bonds that matured in 30 years. UDC had no difficulty selling the bonds because the annual debt service on the bonds was secured by the annual rental payments made by the state under the lease-purchase agreement with the UDC. When the bonds are fully paid off (interest on the bonds will total $290 million), ownership of the prison will revert to the state.

Required:

1. Discuss why New York State might have decided to sell and lease back Attica Prison, rather than sell bonds directly in the capital market, cut expenditures, or raise taxes.
2. Discuss how the state should report the $200 million inflow in its General Fund statement of revenues, expenditures, and changes in fund balances. Rank the alternative reporting methods in order of best method a: (a) revenues, using the caption Other, (b) other financing sources, using the caption Proceeds from sale and leaseback; (c) a special item; and (d) an extraordinary item. Give reasons for your ranking.

For purposes of this problem, assume this item is material. A Securities and Exchange Commission paper says an item is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying on the report would have been changed or influenced by the inclusion of correction of the item. In relation to the states General Fund total revenues that year, $200 million might be considered relatively small, but in relation to the net change in fund balance, it would probably be considered relatively large.