Reference no: EM13901929

ACCOUNTING FOR ATTEMPTED OFF-BALANCE- SHEET FINANCING ARRANGEMENTS.

a. International Paper Company (IP) needs $100 million of additional financing, but because of restrictions in existing debt covenants, it cannot place any more debt on its balance sheet. To obtain the needed funds, it plans to transfer cutting rights to a mature timber tract to a newly created trust as of January 1, Year 8. The trust will use the cutting rights to obtain a $100 million, 5-year, 10% interest rate bank loan due in five equal installments, with interest on December 31 of each year.

The timber will be harvested each year and sold to obtain funds to service the loan and pay operating costs. Based on current prices, 10 percent more standing wood is available for cutting than should be needed to service the loan and pay ongoing operating costs of the tract (including wind, fire, and erosion insurance). If the sell- ing price of timber decreases in the future, the volume of timber harvested will be increased sufficiently to service the debt. If the selling price of timber increases in the future, the volume harvested will remain as originally anticipated, but any cash left over after debt service and coverage of operating costs will be invested by the trust to provide a cushion for possible future price decreases. The value of any cash or uncut timber at the end of five years will revert to IP.

IP will not guarantee the debt. The bank, however, has the right to inspect the tract at any time and to replace IP's forest management personnel with managers of its own choosing if it believes the tract is being mismanaged.

Required

a. Discuss the appropriate accounting for this transaction by IP in light of other FASB pro- nouncements on off-balance-sheet financing.

b. On June 24, Year 4, Delta Air Lines entered into a revolving accounts receivable facil- ity (Facility) providing for the sale of $489 million of a defined pool of accounts receivable (Receivables) through a wholly owned subsidiary to a trust in exchange for a senior certificate in the principal amount of $300 million (Senior Certificate) and a subordinate certificate in the principal amount of $189 million (Subordinate Certificate). The subsidiary retained the Subordinate Certificate, and the company received $300 million in cash from the sale of the Senior Certificate to a third party. The principal amount of the Subordinate Certificate fluctuates daily depending on the volume of Receivables sold and is payable to the subsidiary only to the extent that the collections received on the Receivables exceed amounts due on the Senior Certificate. The full amount of the allowance for doubtful accounts related to the Receivables sold has been retained, as the company has substantially the same credit risk as if the Receivables had not been sold. Under the terms of the Facility, the company is obligated to pay fees that approximate the purchaser's cost of issuing a like amount of commercial paper plus certain administrative costs.

Delta requests your advice on the appropriate accounting for this transaction. How would you respond?

c. In Year 2, a wholly owned subsidiary of Sun Company became a one-third partner in Belvieu Environmental Fuels (BEF), a joint venture formed for the purpose of constructing, owning, and operating a $220 million methyl tertiary butyl ether (MTBE) production facility in Mont Belvieu, Texas. As of December 31, Year 3, BEF had borrowed $128 million against a construction loan facility of which the com- pany guarantees one-third, or $43 million. The plant, which has a designed daily capacity of 12,600 barrels of MTBE, is expected to begin production in mid-Year 4. When production commences, the construction loan will be converted into a five- year, nonrecourse term loan with a first priority lien on all project assets.

To obtain a secure supply of oxygenates for the manufacture of reformulated fuels, Sun has entered into a ten-year take-or-pay agreement with BEF, which commences when the plant becomes operational. Pursuant to this agreement, Sun will purchase all MTBE production from the plant. The minimum per-unit price to be paid for the MTBE production while the nonrecourse term loan is outstanding will equal BEF's annual raw material and operating costs and debt service payments divided by the plant's annual designed capacity. Notwithstanding this minimum price, during the first three years of the off-take agreement, Sun has agreed to pay BEF a price that approxi- mates prices included in current MTBE long-term sales agreements in the marketplace. This price is expected to exceed the minimum price required by the loan agreement. Sun will negotiate a new pricing arrangement with BEF for the remaining years the take-or-pay agreement is in effect. That pricing arrangement will be based on the expected market conditions existing at the time.

How should Sun account for this transaction?