Believer plc entered into a non•cancellable agreement on 1g January 2010 to lease new industrial equipment. The terms of the agreement, which may not be terminated by either party, were that Believer will pay four annual rental payments of £30,000 In arrears with the first payment due on 31g December 2010. Believer may retain the vehicle after the end of the primary lease term on payment of a nominal amount which Is not material.
Believer plc will bear the cost of any loss of or damage to the machine as well as all Insurance and maintenance costs during the period of the lease. The equipment is new and is expected to have a useful life of 5 years after which time it is deemed to have a negligible residual value. The cash price of the equipment would have been £95,100.
Believer plc considers this to be a finance lease. The company depreciates it property, plant and equipment using the straight line method charging a full years depreciation in the year of purchase. Finance charges are allocated using the interest rate Implicit In the lease which is 10%.
Required
(a) Explain why Believer believes this lease should be categorised as a finance lease. You should refer to relevant international accounting standards to justify your answer.
(b) Calculate the total finance charge, annual allocation of finance charge, annual obligation under finance lease (the annual finance lease liability) and net book value of the asset for each of the four years of the lease term.
(c) Show how the transaction would be reflected in the financial statements of Believer plc for the year ended 31" December 2010. This should include both income statement and statement of financial position disclosures.
(d) The major issue surrounding the capitalisation of leases is one of substance over form'. Comment upon this assertion with reference to relevant international accounting standards'.