P Co. is looking for some additional financing in order to renovate one of the company’s manufacturing plants. It is having difficulty getting new debt financing because its debt-to-equity ratio is higher than the 3:1 limit stated in its bank covenant. It is unable to attract an equity partner because the sole owner of P Co. has set equity partner conditions that make it practically impossible to find a new equity investor.
Part of the problem results from the use of historical cost accounting. If the company’s assets were recorded at fair value, the debt-to-equity ratio would be much lower. In order to get around the requirements for historical cost accounting, the CFO for P Co. came up with the following plan.
The existing and pro forma balance sheets (in 000s) and debt-to-equity ratios for P Co. and SPE are presented below in condensed form:
The CFO would like you to prepare a memo in which you discuss the accounting issues related to these proposed transactions.
Prepare the memo requested by the CFO. Ignore income taxes.

  • CreatedJune 08, 2015
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