On 1 April 2007, Fino increased the operating capacity of its plant. Due to a lack of

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Question:

On 1 April 2007, Fino 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, Fino 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 2007. 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 Fino’s income statement and balance sheet for the year ended 30 September 2007 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).