A city is having ﬁscal problems in 2015. It expects to report a deﬁcit in its general fund, the only fund that is statutorily required to be balanced.
To eliminate the anticipated deﬁcit the city opts to “sell” its city hall—to itself—for $5 million. The city establishes a ‘‘capital asset ﬁnancing agency.’’ The agency is a separate legal entity but will have to be reported as a component unit (per standards to be discussed in Chapter 11). As such it will be accounted for in a fund other than the general fund. The city structures the transaction as follows:
• The ﬁnancing agency pays the city $5 million in 2015 in exchange for ‘‘ownership’’ of city hall. The city hall has been carried as general capital asset.
• The agency acquires the necessary cash by issuing 20-year, 6 percent notes. The notes will be repaid in twenty annual installments of $435,920. The notes are guaranteed by the city at large. Hence, they are ultimately a liability payable from the general fund.
• The agency leases the city hall back to the city at large. Lease payments are to be paid out of general fund resources.
1. Prepare journal entries in the general fund to record the sale and concurrent lease-back of the city hall.
The lease-back satisﬁes the criteria of a capital lease transaction.
2. Prepare journal entries in the general fund to record the ﬁrst lease payment, which was made in 2015.
3. Will the transaction, in fact, reduce the 2015 anticipated fund deﬁcit? Brieﬂy justify the accounting principles that underlie this type of accounting.