Leasing- Exam Standard Question

On 1 April 2010, Sincare increased the operating capacity of its plant. Due to a lack of liquid funds it was unable
to buy the required plant which had a cost of $350,000. On the recommendation of the finance director, Sincare
entered into an agreement to lease the plant from the manufacturer. The lease required four annual
payments in advance of $100,000 each commencing on 1 April 2010. The plant would have a useful life of
four years and would be scrapped at the end of this period. The finance director, believing the lease to be an
operating lease, commented that the agreement would improve the company’s return on capital employed
(compared to outright purchase of the plant).
Required
(i) Discuss the validity of the finance director’s comment and describe how IAS 17 Leases ensures that
leases such as the above are faithfully represented in an entity’s financial statements.
(ii) Prepare extracts of Sincare’s income statement and statement of financial position for the year ended 30
September 2010 in respect of the rental agreement assuming:
(1) It is an operating lease
(2) It is a finance lease (use an implicit interest rate of 10% per annum)