Question

On January 1, 2017, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of

$271,622 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2017, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

3. Marlene depreciates all its machinery on a straight-line basis.

4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich.

5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful.

From Marlene’s viewpoint, what type of lease is this?

a) operating lease

b) finance lease

c) manufacturer or dealer lease

d) other finance lease

12. Assume Sunny Corp. (a company reporting under IFRS) wants to earn an 8% return on its investment of $1,200,000 in an asset that is to be leased to Cloudy Corp. for ten years with an annual rental due in advance each year. How much should Sunny charge for annual rental assuming there is no purchase option that is reasonably certain to be exercised by Cloudy Corp.?

a) $120,000

b) $165,588

c) $178,835

d) $216,000

Answer 1

Ans Part 1.
Marlene Corp.
Annual Lease Paymnet	$                271,622
Lease Trem	3 Years
Using the incremental borrowingrate for discounting lease payments ;
Discount rate	10%
PV Annuity factor @10% for 3 yrs=	2.487
PV of Lease Payments =271622*2.487=	$          675,523.91
Faior Value of Equipment	$          700,000.00
Remaining Economic life of machine	10 Years
As the PV of the Lease Payments is considerably lower than
the fair value of the equipment and the lease period
does not cover the maximum of the economic life of
the asset, this Lease agreement is Operating Lease.
So Answer a. is correct.

Ans 12.
Sunny Corp needs 8% return on Investment
Invested amount is $1.2M.
Lease period =10 years
No reasonable sure purchase option from the lessee.
So the PV of the annual lease retals discounted @8% pa
will be equal to $1.2M
Assume the annual lease rental is x.
PV annuity factor for 9 years @8%=	6.247
As the apyment is due in advance each year,the PV for
lease rentals of Yr 2 to 10=x*6.247
PV of Lease rental of first year =x ( no discount)
So PV of Total Lease rentals in 10 yrs=x+6.247*x=7.247*x
so, 7.247*x=$1,200,000
x=165,588
So the Annual Lease rental is $165,588
Option b. is correct.