Lychee Limited (Lychee) was established in January 2010 in Hong Kong. The main business of Lychee is the export of canned lychee to overseas customers. Lychee has its financial year end at 31 December.

In order to expand its overseas business to Mainland China, Lychee plans to build up a logistics team by buying two delivery trucks for the transportation of canned lychee for sales in southern China, including Shenzhen, Guangzhou etc. The fair value of a delivery truck is $600,000 with an expected useful life of eight years.

For the plan to form a logistics team with two delivery trucks, there are two options:

1 Buy the two delivery trucks by applying for a bank loan of $1,200,000 from Blueberry Bank which offers a preferential interest rate of 8%.

2 Lease the two delivery trucks from Melon Limited (Melon) with the following terms:

i The lease term starts on 1 January 2018.

ii The lease is for a minimum period of five years and payments are made as follows:

1 January 2018 $400,000

1 January 2019 $400,000

1 January 2020 $400,000

1 January 2021 $400,000

1 January 2022 $400,000

iii Lychee has to guarantee the value of the delivery trucks at the end of their lives, which is expected to result in a further payment on 31 December 2022 by Lychee to Melon Limited of $30,000 for each delivery truck.

iv The implicit interest rate in the lease is 10%.

v There is no purchase option for Lychee to buy the delivery trucks when the lease term expires.

Lychees accounting policy is to depreciate its non-current assets on a straight-line basis.

Required:

a. Discuss any five factors that Lychee should consider when it decides whether to choose Option A or Option B (15 marks)

b. Prepare journal entries in the books of Lychee in relation to the lease for the year ended 31 December 2018. (15 marks)

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