On January 1, 2011, 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.

(a) What is the theoretical basis for requiring lessees to capitalize certain long-term leases? Do not discuss the specific criteria for classifying a lease as a capital lease.

(b) (1) How should Perriman account for the sale portion of the sale-leaseback transaction at January 1, 2011?

(2) How should Perriman account for the leaseback portion of the sale-leaseback transaction at January 1, 2011?

(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?

(AICPA adapted)