One incentive for entering into a sale-and-leaseback arrangement on substantially all of the market value of an asset is
a. Tax implications are favorable for the lessor, compared with other lending arrangements
b. Improvement in cash flow for the lessor
c. Improvement in cash flow for the lessee
d. Entire gain appears on lessee income statement in sale year
The correct answer and explanation is :
The correct answer is:
c. Improvement in cash flow for the lessee
Explanation:
A sale-and-leaseback arrangement involves a company selling an asset (often property or equipment) to another party (the lessor) and then immediately leasing it back. This arrangement allows the seller (the lessee) to continue using the asset while freeing up capital that was previously tied up in it. Below is a breakdown of why “Improvement in cash flow for the lessee” is the correct answer:
- Cash Flow for the Lessee:
The key benefit for the lessee is the immediate infusion of cash from the sale of the asset. By selling the asset, the lessee can unlock its market value, which can be used for other operational or strategic purposes (such as paying down debt, financing expansion, or increasing working capital). Despite selling the asset, the lessee continues to use it through the leaseback arrangement, meaning they don’t lose the utility of the asset while improving their financial flexibility. - Tax Implications and Financial Considerations:
- a. Tax implications are favorable for the lessor, compared with other lending arrangements: While tax benefits may exist for the lessor (e.g., depreciation deductions), this option does not directly benefit the lessee, so it is not the correct answer.
- b. Improvement in cash flow for the lessor: The lessor does gain cash flow through lease payments from the lessee, but the primary incentive for the lessee is improved cash flow, not for the lessor.
- d. Entire gain appears on lessee income statement in the sale year: This is inaccurate because, in a sale-and-leaseback, the gain from the sale typically isn’t recognized entirely in the year of the sale, especially when the lessee continues using the asset through a leaseback agreement. The treatment depends on the structure of the deal and accounting standards like IFRS or GAAP, and the gain is generally spread over the lease term.
Thus, the primary benefit of a sale-and-leaseback transaction for the lessee is the improvement in cash flow, making option c the correct answer.