Reference no: EM133205983
Assignment:
ADMS Inc. manufacturers mobile phone accessories and operates its own manufacturing plant in Ontario, Canada. ADMS Inc was established by Wong's family in 1999 where the use of mobile phone started to increase. The family sold their cottage and invested the fund to purchase the manufacturing equipment and the manufacturing plant. The equipment has not been replaced since then, and the maintenance cost keeps going up. To improve the operating efficiency and to increase the output; ADMS Inc. has the option to buy or lease the new equipment. ADMS Inc. is leaning toward leasing the equipment as it would not affect its debt-to-equity ratio. The reason is that they have taken out a mortgage using the manufacturing plant as collateral. One of the conditions in the mortgage is that ADMS Inc. must maintain a debt-to-equity ratio of less than 50%, the most recent audited financial statement shows that the ratio is now at 49%. It would exceed the limit if additional funds are borrowed.
ADMS's management is negotiating with the leasing company, LA&PS Inc. to see if anything that could be done to help with the situation. The following terms were offered by LA&PS:
- Lease inception date: January 1, 2022 (payment to be made as soon as the contracts start)
- Terms: 10 years, non-cancellable lease
- Estimated useful life: 12 years
- Fair value of $ 5,200,000
- ADMS's incremental borrowing rate: 10%
- LA&PS's implicit rate: 8%
- Depreciation method: straight-line
- Residual value: $400,000 guaranteed by ADMS Inc.
Presently, ADMS Inc. adopts ASPE. However, the management plans to adopt IFRS next year with their vision to go public in 3 years. As such, the management would like to know the impact on this lease contract regarding this change.
Assume the role as an accountant of ADMS Inc. prepare an analysis with the following details:
1) Overview
2) Analyze the lease contract between ASPE and IFRS
3) Calculate the lease payments, record all required journal entries in 2022. ADMS Inc. records reversing entries after the year-end
4) Recommendation