Problem -
Cavendish Ltd signs a four-year lease agreement with Froom Rentals Ltd on 21 April 2017 for an item of plant equipment that, on this date, has a fair value of $100,452. Cavendish Ltd incurred costs of $148 in negotiating the lease agreement and in preparing the lease documentation.
The lease term commences on 30 June 2017. According to the lease agreement, there are to be four annual payments of $25,000 with the first payment being made on 30 June 2017.
The plant equipment has an expected economic life of five years and a residual value at the end of the lease term of $15,000 and this amount has been guaranteed by Cavendish Ltd. Cavendish Ltd intends to return the plant equipment to Froom Rentals Ltd at the end of the lease term.
The terms of the lease agreement specify that if Cavendish Ltd cancels the lease then Cavendish Ltd must immediately pay an amount equal to the remaining lease payments and the guaranteed residual value to Froom Rentals Ltd.
The policy of Cavendish Ltd is to depreciate similar assets using the straight-line basis.
The interest rate implicit in the lease is 8%.
Required:
1. What are the minimum lease payments in this lease agreement?
2. If this lease agreement was classified as a finance lease what does AASB 117 Leases require the lessee (Cavendish Ltd) and the lessor (Froom Rentals Ltd) to do (i.e. which financial elements should be recognised) at the commencement of the lease? Also discuss at which value these financial elements should be recognised.
3. Over what time period should Cavendish Ltd depreciate the item of plant equipment? What residual value, if any, should it be depreciated to?
4. Apply the requirements of AASB 117 Leases to determine whether Cavendish Ltd would classify this lease agreement as either an operating lease or as a finance lease. Justify your answer.
5. Determine the amounts that Cavendish Ltd would recognise at the commencement of the lease and prepare the lease payments schedule.
6. Prepare the necessary journal entries to account for the lease.