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:
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Date of purchase or signing of lease
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January 1, 2014
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Purchase price equal to fair value at January 1, 2014
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$79,000
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Cost to BMW Canada
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$70,000
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Physical life
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8 years
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Useful life to Sanderson
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5 years
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Residual value at January 1, 2019, equal to fair value
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$10,000
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Fair value at January 1, 2017
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$39,500
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Borrowing terms with Western Bank for purchase: Option 1
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Loan amount
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$79,000
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Fixed bank rate for loan to purchase
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7%
|
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Term of loan to purchase
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5 years
|
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Repayment terms
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Quarterly instalment note
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|
First payment due
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April 1, 2014
|
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For Option 2:
Terms, conditions, and other information related to the initial lease with BMW Canada:
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Lease term
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36 months
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First lease payment date
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January 1, 2014
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Monthly lease payment
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$1,392.21
|
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Maximum number of kilometres allowed under lease
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72,000
|
|
Excess kilometre charge beyond 72,000 km
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25 cents
|
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Option to purchase price at end of lease
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50% of original fair value
|
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Date of payment for option to purchase
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January 1, 2017
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|
Maintenance and insurance
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paid by Sanderson
|
|
Interest rate stated in lease-annual
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6%
|
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Sanderson's incremental borrowing rate
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7%
|
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Terms, conditions, and other information related to the renewal option for lease with BMW Canada:
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Renewal lease term
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24 months
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Renewal option first lease payment date
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January 1, 2017
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Monthly lease payment
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$1,371.00
|
|
Maximum number of kilometres allowed under renewal lease
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48,000
|
|
Excess kilometre charge beyond 48,000 km
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25 cents
|
|
Option to purchase at end of renewal option
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none
|
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Maintenance and insurance
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paid by Sanderson
|
|
Renewal option
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none
|
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Interest rate stated in renewal lease
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7%
|
|
Sanderson's incremental borrowing rate (projected)
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8%
|
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Borrowing terms with Western Bank to exercise option to purchase: Option 3
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Loan amount
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$39,500
|
|
Bank rate January 1, 2017
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8%
|
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Term of loan January 1, 2017
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2 years
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Repayment terms
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Quarterly instalment note
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|
First payment due
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April 1, 2017
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