Styles Ethical Dilemma You are an accountant for ACME Mining Company and your CF
ID: 2517947 • Letter: S
Question
Styles Ethical Dilemma You are an accountant for ACME Mining Company and your CFO gives you a copy of a recent lease agreement to record. As you read the agreement, you discover the company has leased 12 trucks from World Finance Inc. The fair value of the trucks is $2.4 million. ACME Mining Company has agreed to pay $250,000 semiannually, in advance. The lease termsis 5 years, and the lessor's implicit rate is 8%. There is no option or requirementto purchase the trucks. This all seems straightforward, especially when you remember that the company recently borrowed from a bank and agreed to a 10% interest rate. Also, you recall that the company owns some similar trucks and depreciates them over 8years. You are about to leave the office early to meet some friends when you notice that there a contingent rental of $97,592 payable by ACME Mining Company and starting with the seventh semiannual paymentif the Consumer Price Index prevailing at the beginning of the lease increases in any one of the first 3 years of the lease. Required: From financial reporting and ethical perspectives, discuss the issues raised by this situation.Explanation / Answer
Financial issues in this situation
Here let us try to compare the cost of hiring v/s the cost of buying (on loan).
Now since the periods of hiring and loan are different with different payment terms let us compute the annualised payment under hire and under loan, so that the amounts are comparable.
Under Hire
Under Loan
Issues:
Hence we can see a clear disadvantage in the hire purchase agreement from financial perspective.
Ethical issues in this situation
There is no option or requirement to purchase the trucks, still the trucks are being purchased
The trucks are purchased in large numbers and at costs higher than previous purchases.
Year Semi Annual Lease payment Contingental Rental Total Rental Disc. Factor @8% Disc. Factor @8% PV 1 1 250000 250000 1 1 250,000 1 2 250000 250000 0.961538462 0.961538462 240,385 2 3 250000 250000 0.924556213 0.924556213 231,139 2 4 250000 250000 0.888996359 0.888996359 222,249 3 5 250000 250000 0.854804191 0.854804191 213,701 3 6 250000 250000 0.821927107 0.821927107 205,482 4 7 250000 97592 347592 0.790314526 0.790314526 274,707 4 8 250000 97592 347592 0.759917813 0.759917813 264,141 5 9 250000 97592 347592 0.730690205 0.730690205 253,982 5 10 250000 97592 347592 0.702586736 0.702586736 244,214 6 11 0.675564169 6 12 0.649580932 7 13 0.62459705 7 14 0.600574086 8 15 0.577475083 8 16 0.555264503 Total 8.435331611 12.11838743 2,400,000 Semiannualised payment at beginning of period if bought on loan= 2400000/8.435331611 284,518