FINANCIAL REPORTING

APPENDIX 1

Appendix 1
Case study data

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Case study
A manufacturing company has been analysing proposals for a major acquisition of new
equipment by either lease or purchase. The lease proposal was considered to be the more
desirable option.
The lease agreement, which was signed on 30 June 20X6, involves equipment that has a fair
value of $900000. Theequipment would be leased for a period of 10 years beginning 30 June
20X6. Thelease agreement can be cancelled only if the lessee replaces it with a new lease for
the same or equivalent property with the lessor. Anannual lease payment of $152000 is due on
30June each year; the first payment is to be made on 30 June 20X6. Maintenance costs will
be paid by the lessee as they are performed. Estimated annual maintenance costs are $8500.
The lessor will pay all insurance premiums, which amount to $3600 annually and are included
in the annual lease payment of $152 000. The estimated useful life (and economic life) of the
equipment is 14 years, and its salvage value in the used equipment market is estimated to be
$60 000 after 14 years. The manufacturing company is informed by the financing company that
the interest rate implicit in the lease is 16percent.
The residual value of the equipment is $300 000 and the lessee has guaranteed this residual.
The lessee plans to make an offer to purchase the equipment for the guaranteed residual value
at the end of the lease term. There is no reason to believe that the offer will be refused.