In its ongoing efforts to make the student life easier, Large Mart is currently attempting to develop a “study pillow” which will allow students to upload study material into their brain whilst sleeping. However, Large Mart has recently discovered that an American company called Bpple already holds a patent for this type of device. As a result, Large Mart has given up on its development attempts and decided to sell the Bpple product, which is called iSLEEP.
On 1st July 201x, Large Mart leases a company car for the service department of the new store (called the “Nerd Herd”). The duration of the lease is 5 years, and the car has an expected useful life of 8 years. The lease contract requires Large Mart to pay $10,000 (via bank transfer) on 30th June of each year during the lease period. The lease contract states that Large Mart may cancel the lease once the contract is signed, but that Large Mart will have to pay a transaction fee of $100 if the lease is cancelled prior to the end of the contract. At the end of the lease period, Large Mart will be able to purchase the car for a payment of $10,000. It is expected that the car has a fair value of $5,000 at the time Large Mart is able to exercise this purchase option. The interest rate in the lease is 12%. Large Mart decided to enter into the lease agreement instead of purchasing the car because the purchase price would have been $41,000 and Large Mart did not have sufficient cash resources to make such a purchase at that time.
Determine if the lessor will have to account for the outlined car lease as an operating lease or a finance lease, AND provide a detailed explanation for your decision.