Holmes Ltd, which has a year end of 30 September, is considering the replacement of its now outdated mainframe computer on 1 October 1988. The replacement computer has a cost of \(£ 2120000\) and its useful economic life is estimated at 7 years. After negotiations with a leasing company, Duff Ltd, and other financial institutions, the directors of Holmes Ltd have identified three options available to them for consideration:

\section*{Option A}

Enter a 4 -year lease with Duff Ltd for total lease payments of \(£ 2000000\) payable in four equal instalments, the first instalment being due on day 1 of the leasing period. Under this arrangement Duff Ltd would have responsibility for upkeep and maintenance and has negotiated a guaranteed repurchase by the manufacturer at the end of the lease term. The interest rate implicit in the lease is \(10 \%\).

\section*{Option B}

Enter a 4 -year lease with the same rental payment arrangements as Option A, but at the end of four years, commence a secondary rental period which provides for 3 annual payments of \(60 \%, 40 \%\) and \(20 \%\) respectively of annual rental payments in the primary period. Under the terms of this lease, Holmes Ltd would be responsible for the maintenance and upkeep. The interest rate implicit in the lease is \(10.25 \%\).

\section*{Option C}

Purchase the new computer outright by issuing sufficient \(£ 100\) debentures at a price of \(£ 55\). The debentures would carry a coupon of \(2 \%\) and would be redeemable at par, 7 years after the date of issue.

Required

(a) With regard to Option A, demonstrate whether the arrangement should be treated as a finance or operating lease in the accounts of Holmes Ltd.

(b) With regard to Option B, calculate the amounts to be shown in the profit and loss account of Holmes Ltd for each of the years ending 30 September 1989 and 1990. Also calculate the amounts to be disclosed in the balance sheet at 30 September 1989 and draft the related notes thereto.

(c) Identify the principles underlying the treatment recommended in SSAP 21 with regard to the accounting for finance leases in the books of the lessor.

(d) Describe and assess the alternative methods of accounting in the books of Holmes Ltd for the financing arrangements outlined in Option C.d