Reference no: EM132903972
Question - On November 1, 2019 (the beginning of the fiscal year), CAP acquired a portion of its equipment through a lease agreement with Lessor Corp. The lease contract has the following terms and conditions:
CAP agrees to lease equipment from Lessor Corp. with a fair market value of $900,000.
The term of the lease is for seven years, with annual rental payments of $145,000 due at the beginning of each year. CAP knows the implicit interest rate on the lease agreement is 5%. CAP knows that it could borrow at an incremental rate of 6%.
There is no residual value.
CAP will cover the executory costs associated with the lease. The executor costs will be approximately $10,000 per annum and are included as part of the $145,000 rental payment.
The lease offers a bargain purchase option to purchase the equipment for $50,000 at the end of the seventh year. At the end of year seven, the fair market value of the asset is expected to be $70,000.
The first payment was made on November 1, 2019, with annual payments thereafter.
You remember from auditing a client in the past that equipment such as this usually has an economic life of nine years. CAP has classified this lease as an operating lease. You remember from your discussion with Robert that he was unsure of the benefits of leasing versus buying an asset. This information is important for Robert for any future capital budgeting decisions.
Required - Explain the issues within this problem and resolve the issues under both IFRS and ASPE.
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