AC3202 Corporate Accounting I, Semester A, 2018/19 (Weeks 7-9)

Accounting for Leases – suggested answers for Assignments

Question 1
Yearly payment $144,000
Less: Taxes (executory costs)   4,941
Minimum annual lease payment $139,059

Present value of minimum lease payments (PVMLP):$139,059 x (1+ 5.32825) = $880,000

(5.32825 being the PVIFA value where i= 12%, n=9). Note that PVMLP=Fair value in this question.
Lease payments Interest Reduction in Lease liabilities
exclude taxes $ expense $ lease liabilities $ $
Date (A) (B) (A)-(B)=(C) (D)
1.1.2016 880,000
1.1.2016 139,059 --- 139,059 740,941
1.1.2017 139,059 88,913 50,146 690,795
1.1.2018 139,059 82,895 56,164 634,631
Note: (B)=(D) of last period x 12%; (D)=(D) of last period –(C)

1/1/16 Leased Building..................................... 880,000

Lease Liability............................................. 880,000

1/1/16 Cost for service—Taxes...............................4,941

Lease Liability..........................................139,059
Cash............................................................. 144,000

12/31/16 Depreciation Expense–leased building......88,000

Accumulated Depreciation-leased building 88,000
  ($880,000 ÷ 10)

12/31/16 Interest Expense .......................................88,913

Interest Payable........................................... 88,913

1/1/17 Cost for service—Taxes...............................4,941

Interest Payable..........................................88,913
Lease Liability............................................50,146
Cash............................................................. 144,000

12/31/17 Depreciation Expense–leased building......88,000

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 Accumulated Depreciation-leased building 88,000

12/31/17 Interest Expense.........................................82,895

Interest Payable........................................... 82,895

Question 2

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(a) The lessor’s implicit rate (10%) is known to the lessee.  So, both parties’ calculations 
should be made using a 10% discount rate.  

Application of Classification Criteria

1 Does the agreement specify that 
ownership of the asset transfers 
to the lessee? NO

2  Does the agreement contain a 
bargain purchase option? NO

3  Is the lease term for the major part of the  
economic life of the asset even if title NO
is not transferred? {4 yrs < 75% of 6 yrs}

4  Is the present value of the  YES
minimum lease payments amounts to at least {$348,685a > 90% of
substantially all of the fair value of the leased assets $365,760} 
                                       
5. Is the leased asset of a specialized nature such that 
only the lessee can use it without major modification
being made? NO

a. See calculation below.

Present Value of Minimum Lease Payments

Present value of periodic rental payments ($100,000 x 3.48685)=$348,685

* Since the residual value is not guaranteed, it is excluded from the lessee’s minimum
lease payments.

B Ltd. (the lessee)

Lessee - recognise assets and liabilities for all leases with a term of more than 12 months,
unless the underlying asset is of low value.

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Lessee - MLP (unguaranteed residual value excluded)

Date Payments Interest Reduction in Lease liability ($)

($) expense ($) Lease liability ($)
1-1-2016 348,685
1-1-2016 100,000 100,000 248,685
31-12-2016 100,000 24,869 75,131 173,554
31-12-2017 100,000 17,355 82,648 90,909
31-12-2018 100,000 9,091 90,909 0
31-12-2019 - - - -
Total 400,000 51,315 348,685*

* $3 being rounding difference

(b) January 1, 2016
Leased equipment.......................................................................... 348,685
Lease liability............................................................................
348,685

Lease liability................................................................................ 100,000

Cash ..........................................................................................
100,000

December 31, 2016
Depreciation expense for leased equipment ([$348,685] ÷ 4 years) 87,171
Accumulated depreciation for leased equipment...................... 87,171

Lease liability................................................................................ 75,131
Interest expense (10% x [$348,685– 100,000])............................. 24,869
Cash...........................................................................................
100,000

(c) December 31, 2019
Depreciation Expense for leased equipment ................................ 87,171
Accumulated depreciation for leased equipment...................... 87,171

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Accumulated depreciation for leased equipment (account balance) 348,685
Leased equipment (account balance)........................................
348,685

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Question 3
(a) The lease is an operating lease to lessor because:
1. Ownership of the asset is not transferred to the lessee by the end of the lease term.
2. The lease does not contain a bargain purchase option.
3. The lease term of 5 years is not for the major part of the economic life of the
equipment (12 years).
4. The present value of the minimum lease payments amounts does not represent
substantially all of the fair value of the leased asset. (guideline: > 90% of the fair
value)
The implicit interest rate of 9% is known to Y Ltd. So using 9% and 5 years, the
Present value is
$22,000 X 4.23972 = $93,274 < $144,000 (90% X $160,000)
5. The leased asset is not of a specialized nature such that only the lessee can use it
without major modifications being made.

For lessor, at least one of the five criteria would have had to be satisfied for the lease
to be classified as finance lease other than operating lease.

(b)
Lessor’s Entries
Insurance Expense.......................................................................... 500
Tax Expense..................................................................................2,000
Maintenance Expense......................................................................650
Cash or Accounts Payable............................................................ 3,150

Depreciation Expense.................................................................12,500
Accumulated Depreciation—Equipment..................................... 12,500
  [($160,000 – $10,000) ÷ 12]

Cash ...........................................................................................22,000
Rent Revenue............................................................................... 22,000