Question

(Sale-Leaseback) On January 1, 2017, Perriman Company sold equipment for cash and leased it back. As seller-lessee, Perriman retained the right to substantially all of the remaining use of the equipment.

The term of the lease is 8 years. There is a gain on the sale portion of the transaction. The lease portion of the transaction is classified appropriately as a capital lease.

Instructions

(c) How should Perriman account for the gain on the sale portion of the sale-leaseback transaction during the first year of the lease? Why?

Short answer

Answer

The deferred gain should be amortized over the lease term or life of the asset, whichever is appropriate.

Step-by-step solution

Step-by-Step Solution

Step 1: Meaning of Lease

A lease is a mutual agreement in which one party transfers the right to use the property to the other party for a specified amount and time. The lease is terminated after the completion of the lease period.

Explaining the Perriman account for the gain on the sale portion of the sale-leaseback transaction during the first year of the lease

The deferred gain should be amortized throughout the lease period or the asset's lifetime, whichever comes first. The amortization will be proportional to the asset's amortization during the first year of the lease.

Since the sale and leaseback are two components of a single transaction rather than two separate transactions, this deferral and amortization procedure is necessary for a sale-leaseback transaction. The gain (unearned profit) should be delayed and amortized throughout the lease term due to the interdependence of the sale and leaseback elements of the transaction.