1FINANCIAL REPORTING APPENDIX 1

Appendix 1Case study data

You may care to remove this page to be able to refer to the case study data when working through the module material and questions which use the case study data.

Case studyA 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 $900 000. The equipment would be leased for a period of 10 years beginning 30 June 20X6. The lease agreement can be cancelled only if the lessee replaces it with a new lease for the same or equivalent property with the lessor. An annual lease payment of $152 000 is due on 30 June 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 16 per cent.

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.