On January 1, 2010, Metcalf Company sold equipment for cash and leased it back. As seller lessee, Metcalf retained the right to substantially all of the remaining use of the equipment. The term of the lease is eight 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.
Required
1. Explain 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.
2. a. Explain how Metcalf should account for the sale portion of the sale leaseback transaction at January 1, 2010.
b. Explain how Metcalf should account for the leaseback portion of the sale leaseback transaction at January 1, 2010.
3. Explain how Metcalf should account for the gain on the sale portion of the sale leaseback transaction during the first year of the lease.