Power Station Case Study

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TO: xxxx, CFO FROM: xxxx, Senior Accountant DATE: June 30, 2009 SUBJECT: Accounting for Leasing Arrangement with Energy Corporation As you requested, I have analyzed the proposed leasing arrangement with Energy Corp. Based on my analysis, the best option is to purchase the turbines rather than lease them. OVERVIEW: Power Station is contemplating whether to enter into a sale-leaseback transaction with Energy Corporation. Power Station will purchase turbines and immediately sell them to Energy Corp. who will then lease them back to Power Station. According to the regulations, Power Station is required to purchase and take title to the turbines. At the end of the 5-year lease term, Power Station has the option to buy the equipment at fair market value. If the option is not exercised, Power Station is responsible for de-installation costs ($7 million) and the cost to ship and install the equipment at a new site ($7.3 million). ISSUE: Whether Power Station should lease the turbines through Energy Corporation using a sales-leaseback transaction? At the conclusion of the lease, should Power station exercise the purchase option to buy the equipment? ANALYSIS: The leasing arrangement is considered a sale-leaseback transaction because “it involve[s] the sale of property by the owner and the lease of the property back to the seller (FAS 28, 1976, ¶2). The lease agreement is classified as an operating lease because it does involve a transfer of ownership, a bargain purchase option, a term of greater than 75% of the turbine’s useful life, or minimum lease payments that exceed 90% of the equipment’s fair value (1976, ¶7). Power Station would simply record a credit to cash and a debit to lease expense for the payment amount each of the 5 years in the lease term. Power Station’s may benefit from entering into the sale-leaseback transaction because the turbines would

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