In the effort to improve financial performance and keep debt off the balance she
ID: 2425770 • Letter: I
Question
In the effort to improve financial performance and keep debt off the balance sheet whenever possible, many companies have turned to Special Purpose Entities to finance some of their activities. A Special Purpose Entity (SPE) is a separate business entity created to perform certain projects or activities. Assume that Brown Company creates a SPE to borrow the money and acquire or build an asset and then lease it to Brown Company. Assuming the lease is structured as an operating lease, Brown shows no asset or liability on their financial statements, just periodic lease payments are expensed. However, for tax purposes the Brown Company is assumed to own the asset and records depreciation expense at accelerated tax rates for the asset, thereby reducing their tax obligation. Do you see any ethical problems with this scenario? If so, what are they?
Explanation / Answer
In this case, there is an issue of seperate legal entity.First of all, if Brown Company should not show the depriciation expense in their books , since the asset belongs to the SPE. The tax return for SPE should show the assets and claim depriciation thereafter.
If, brown company itself is leasing ,operating the assets and lending it to Brown Company, there is a corporate veil which has to be lifted in this case.Because such situation gives rise to conflict of interest.