Ask Question, Ask an Expert

+61-413 786 465

info@mywordsolution.com

Ask Financial Accounting Expert

Lessee Ltd., the British company which applies IFRSs, leased equipment from Lessor Inc. on January 1, 2007, for period of three years. Lease payments of $100,000 are due to Lessor Inc. each year. Other expenses (like insurance, taxes, maintenance) are also to be paid by Lessee Ltd. and amount to $2,000 per year. Lessor did not incur any initial direct costs. Lease contains no purchase or renewal options and equipment reverts back to Lessor Inc. on expiration of the lease. The remaining useful life of the equipment is four years. Fair value of the equipment at lease inception is $265,000. Lessee Ltd. has guaranteed $20,000 as the residual value at the end of lease term. $20,000 represents the expected value of the leased equipment to the lessee at the end of a lease term. Salvage value of an equipment is expected to be $2,000 after the end of its economic life. Lessee’s incremental borrowing rate is 11 percent (Lessor’s implicit rate is 10 percent and is calculable by lessee from the lease agreement).

Junior accountant of Lessee Ltd. analyzed assets under lease and prepared the computation. The senior accountant of Lessee Ltd. reviewed the analysis and the computation and prepared a separate analysis. As the finance controller, you were given both of the computations to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant are below.

Present Value of the Lease Obligation:

Using rate implicit in lease (10 percent), present value of a guaranteed residual value would be $15,026 ($20,000 × 0.7513), and present value of annual payments would be $248,690 ($100,000 × 2.4869).

Using incremental borrowing rate (11 percent), present value of the guaranteed residual value would be $14,624 ($20,000 × 0.7312), and present value of the annual payments would be $244,370 ($100,000 × 2.4437).

Computations by junior accountant:

As the equipment reverts back to Lessor Inc., it is the operating lease.
Entries to be posted in Years 1, 2, and 3:
Dr. Lease expense:      $100,000
Dr. Insurance expense: $2,000
Cr. Cash:                   $102,000
(Operating lease rental paid to Lessor Inc.)

Computations by senior accountant:

Step 1: Lease classification
Lease term is for three years. The useful life of the equipment is four years. As the lease term is for a major part of the useful life of the equipment, it is a finance lease.

Step 2: Computation of lease asset and obligation
As the lessee’s incremental borrowing rate is greater than the lessor’s implicit rate in the lease, compute the present value of the minimum lease payments using the 11 percent rate.
Present value of the minimum lease payments = $100,000 × 2.4437 = $244,370.

Step 3: Allocation of payments between interest and lease obligation
Since interest has to be charged on the straight-line method, the following is the allocation of the interest and the reduction in the lease liability.

Year    Cash Payment          Interest Expense (11%)     Reduction in Lease Obligation   Balance of Lease Obligation
                   $                                       $                                      $                                    $
0
                                                                                                                                        244,370
1              100,000                              26,881                                73,119                              171,251
2              100,000                              26,881                                73,119                               98,131
3              100,000                              26,881                                73,119                               25,012

Journal entry in Year 1 to record the payments:
Dr. Rent expense:      $2,000
Dr. Interest expense: $26,881
Dr. Lease obligation:  $73,119
Cr. Cash:                 $102,000

Required:
1. Was the junior accountant’s analysis correct? Why or why not?
2. Was the senior accountant’s analysis correct? Why or why not?
3. How would the answer differ under U.S. GAAP?

Financial Accounting, Accounting

  • Category:- Financial Accounting
  • Reference No.:- M9376

Have any Question? 


Related Questions in Financial Accounting

Asset retirement obligation changes in estimate versus

Asset Retirement Obligation, Changes in Estimate versus Errors, Writing an Issues Memo Facts: Mega¬Corp's corporate headquarters, built in 1970, has asbestos in its insulation. The Company's financial statements reflect ...

An investment offers 6800 per year with the first payment

An investment offers $6,800 per year, with the first payment occurring one year from now. The required return is 7 percent. a. What would the value be today if the payments occurred for 20 years?  b. What would the value ...

Finance final exam -answer the following questions based on

FINANCE Final Exam - Answer the following questions based on the course presentation, text, and any outside relevant sources. Use citations and show your work where applicable. 1. Strategic and Financial Planning a. Defi ...

What has been strides position on dividend payouts in the

What has been Strides' position on dividend payouts in the past (pattern, relationship with earnings, etc.)? What factors affected its dividend policy?

Chelsea is expected to pay an annual dividend of 126 a

Chelsea is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth 2.6 percent. What is the cost of equity?

Sweet treats common stock is currently priced at 3672 a

Sweet treats common stock is currently priced at $36.72 a share. The company just paid $2.18 per share as its annual dividend. The dividends have been increasing by 2,2 percent annually and are expected to continue doing ...

Accounting for decision makingquestion discuss the five key

Accounting for decision making. Question: Discuss the five key forces to consider when analyzing an industry. How do these forces impact the balanced scorecard? Reply to the discussion which are attached. Discussion: For ...

Ha 3011 advanced financial accounting assignment

HA 3011 Advanced Financial Accounting Assignment - Assessment Task Part A - In an article entitled 'Unwieldy rules useless for investors' that appeared in the Australian Financial Review on 6 February 2012 (by Agnes King ...

Highway express has paid annual dividends of 132 133 138

Highway Express has paid annual dividends of $1.32, $1.33, $1.38, $1.40, and $1.42 over the past five years, respectively. What is the average divided growth rate?

Comprehensive problem - lou barlow a divisional manager for

Comprehensive Problem - Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products for a five-year period. His annual pay raises are determined by his division's ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

Why might a bank avoid the use of interest rate swaps even

Why might a bank avoid the use of interest rate swaps, even when the institution is exposed to significant interest rate

Describe the difference between zero coupon bonds and

Describe the difference between zero coupon bonds and coupon bonds. Under what conditions will a coupon bond sell at a p

Compute the present value of an annuity of 880 per year

Compute the present value of an annuity of $ 880 per year for 16 years, given a discount rate of 6 percent per annum. As

Compute the present value of an 1150 payment made in ten

Compute the present value of an $1,150 payment made in ten years when the discount rate is 12 percent. (Do not round int

Compute the present value of an annuity of 699 per year

Compute the present value of an annuity of $ 699 per year for 19 years, given a discount rate of 6 percent per annum. As