Question

In its ongoing efforts to make the student life easier, Large Mart is currently attempting to develop a “study pillow” which will allow students to upload study material into their brain whilst sleeping. However, Large Mart has recently discovered that an American company called Bpple already holds a patent for this type of device. As a result, Large Mart has given up on its development attempts and decided to sell the Bpple product, which is called iSLEEP.

In order to sell the iSLEEP, Large Mart has rented a second store in Armidale. Large Mart signs a one year renting contract on 1st May 201x. The rent for the store will be $250 per month, and the renting contract requires Large Mart to prepay all of the rent for the year on 1st May 201x,

As soon as the renting contract for the new store is signed, Large Mart employs a UNE student (Morgan) to manage an iSLEEP fan-site on Facebook. Morgan is employed for 2 hours every day of the week (7 days a week). He starts his jobs on 1st May 201x and will be paid $30 per hour. Morgan’s wage for May will be paid on the 15th June.

The furniture in the new store is designed in Shanghai and manufactured in Melbourne. An important part of the store design is a big bed on which customers can lie to test the iSLEEP before purchasing the product. The bed is delivered on 1st June 201x. On that day, Large Mart also receives an invoice of $40,000 from the Melbourne manufacturer of the bed, as well as an invoice of $20,000 from the designers of the bed. When the bed was produced in Melbourne, the director of the Large Mart sales department visited the manufacturing team to approve the final design of the bed before the start of the manufacturing process. The director did not make this trip for the specific purpose of visiting the manufacturing team. Instead the director traveled to Melbourne to attended a meeting with a business partner, and visited the manufacturing team for only 1 hour. The costs of the director’s trip to Melbourne are $1,500 for flights and $200 for a return taxi fare between the Large Mart business partner that the director visited and the site where the manufacturing team built the bed. All costs of this trip were incurred on credit and will be paid on 15th July 201x.

After the new store is completed, Large Mart orders 30 iSLEEPs from Bpple for a price of $500 per iSLEEP, and these iSLEEPs arrive on 1st June 201x and are paid via bank transfer on 20^th June.

On 5th June 201x, UNE purchases 10 iSLEEPs for the library for a price of $2,100 per iSLEEP on credit. UNE then pays the iSLEEPs on 10th June 201x, after deducting an early payment discount of 10%.

On 7th June 201x, the UNE library returns two of the iSLEEPs that were purchased on 5th June 201x because they are damaged. Large Mart accepts the return and reduces the invoice (which will be paid on 10th June) for UNE by the full price of both iSLEEPs. Large Mart destroys the two damaged iSLEEPs as they are not in a condition that would allow them to be re-sold (Large Mart will not receive any compensation from Bpple).

On 8th June 201x, Large Mart purchases another 60 iSLEEPs from Bpple for a special price of $490. Normally the iSLEEP would currently cost $500, but Large Mart was able to receive a volume discount of $10 for each iSLEEP. The iSLEEPs arrive on the same day, and Large Mart pays this new delivery of iSLEEPs two days later.

On 12th June 201x, Large Mart sells 10 iSLEEPs to Wright College for $1,600 per iSLEEP. Wright College pays via bank transfer on the same day.

On 1st July 201x, Large Mart leases a company car for the service department of the new store (called the “Nerd Herd”). The duration of the lease is 5 years, and the car has an expected useful life of 8 years. The lease contract requires Large Mart to pay $10,000 (via bank transfer) on 30th June of each year during the lease period. The lease contract states that Large Mart may cancel the lease once the contract is signed, but that Large Mart will have to pay a transaction fee of $100 if the lease is cancelled prior to the end of the contract. At the end of the lease period, Large Mart will be able to purchase the car for a payment of $10,000. It is expected that the car has a fair value of $5,000 at the time Large Mart is able to exercise this purchase option. The interest rate in the lease is 12%. Large Mart decided to enter into the lease agreement instead of purchasing the car because the purchase price would have been $41,000 and Large Mart did not have sufficient cash resources to make such a purchase at that time. Australian Accounting Standards

Question 6) Determine if the lessor will have to account for the outlined car lease as an operating lease or a finance lease, AND provide a detailed explanation for your decision (2.5 marks).

Answer 1

The lease will be considered as a financial lease by the lessor due to the following reasons:

1. The useful life of the car is 8 years and the car is being leased out for 5 years. The lease period covers a significant portion of the asset's useful life.

2. The present value of annual lease payments comes out to be $36,048 (rate=12%, period=5 years, payment=10,000). This is close to 90% of the original cost of the asset.

3. The lessee has the option to buy the assets at the end of lease period by paying certain amount