Reference no: EM131772418

Sanderson Inc., a pharmaceutical distribution firm, is providing a BMW car for its chief executive officer as part of a remuneration package. Sanderson has a calendar year end, issues financial statements annually, and follows ASPE. You have been assigned the task of calculating and reporting the financial statement effect of several options Sanderson is considering in obtaining the vehicle for its CEO.

Option 1: Obtain financing from Western Bank to finance an outright purchase of the BMW from BMW Canada, which regularly sells and leases luxury vehicles.

Option 2: Sign a lease with BMW Canada and exercise the option to renew the lease at the end of the initial term.

Option 3: Sign a lease with BMW Canada and exercise the option to purchase at the end of the lease. The amount of the option price is financed with a bank loan.

For the purpose of your comparison, you can assume a January 1, 2014 purchase and you can also exclude all amounts for any provincial sales taxes, GST, and HST on all the proposed transactions. You can also assume that Sanderson uses the straight-line method of depreciating automobiles. Assume that for options 1 and 2, the BMW is sold on January 1, 2019, for $10,000.

Sanderson does not expect to incur any extra kilometre charges because it is likely that the BMW won't be driven that much by the CEO. However, there is a 10% chance that an extra 10,000 km will be driven and a 15% chance that an extra 20,000 km will be used.

Terms and values concerning the asset that are common to all options are the following:

Date of purchase or signing of lease January 1, 2014 Purchase price equal to fair value at January 1, 2014 $79,000 Cost to BMW Canada $70,000 Physical life 8 years Useful life to Sanderson 5 years Residual value at January 1, 2019, equal to fair value $10,000 Fair value at January 1, 2017 $39,500

Borrowing terms with Western Bank for purchase: Option 1

Loan amount $79,000 Fixed bank rate for loan to purchase 7% Term of loan to purchase 5 years Repayment terms Quarterly instalment note First payment due April 1, 2014

For Option 2:

Terms, conditions, and other information related to the initial lease with BMW Canada:

Lease term 36 months First lease payment date January 1, 2014 Monthly lease payment $1,392.21 Maximum number of kilometres allowed under lease 72,000 Excess kilometre charge beyond 72,000 km 25 cents Option to purchase price at end of lease 50% of original fair value Date of payment for option to purchase January 1, 2017 Maintenance and insurance paid by Sanderson Interest rate stated in lease-annual 6% Sanderson's incremental borrowing rate 7%

Terms, conditions, and other information related to the renewal option for lease with BMW Canada:

Renewal lease term 24 months Renewal option first lease payment date January 1, 2017 Monthly lease payment $1,371.00 Maximum number of kilometres allowed under renewal lease 48,000 Excess kilometre charge beyond 48,000 km 25 cents Option to purchase at end of renewal option none Maintenance and insurance paid by Sanderson Renewal option none Interest rate stated in renewal lease 7% Sanderson's incremental borrowing rate (projected) 8%

Borrowing terms with Western Bank to exercise option to purchase: Option 3

Loan amount $39,500 Bank rate January 1, 2017 8% Term of loan January 1, 2017 2 years Repayment terms Quarterly instalment note First payment due April 1, 2017