Question

On 1 January 20x1, Success Co. entered into a lease agreement to lease a highly specialised machinery (which had a useful life of 20 years) from Victory Leasing Co.

Victory Leasing Co. had bought the new machinery for a cash consideration of $1,122,095.

The terms of the lease agreement included the following:

1. Non-cancellable lease term of 15 years, with a renewal option for another 5 years
2. Lease rental of $100,000 per year for the first 15 years and $50,000 per year for the last 5 years (if the option was exercised), to be paid on 31 December of each year, commencing 31 December 20X1

3. If the lease was extended to 20 years, Success Co. had to pay $150,000 to dismantle the machinery.

At the commencement date, Success Co. was reasonably certain that it will extend the lease to 20 years.

The rate of return of the lease was 5%. Success Co.’s incremental borrowing rate was 4%.

The initial direct cost paid by Success Co. was $20,000. Victory Leasing Co. had also paid $20,000 of initial direct cost.

Assume the asset was depreciated using straight-line basis with no residual value.

Required:

Prepare appropriate journal entries (with reference to IFRS 16-Leases) for Success Co. and Victory Leasing Co for the year 20x1. Assume a December 31 year-end.

Answer 1

1.Journal entry in the books of Sucess Co( Lessee)-

january 1,2001    ROU assets Account Dr.-------1218700    To Lease Liability(WN-1)---------------1142150    To dismantaling liability---------------- 56550    To Bank-------------------------------------20000 ----------------------------------------------------------------------------------------------------------------------------- December 31,2001    Interest on lease liability Dr.-----------------57108 (1142150*5%) To Lease Liability    ------------------57108 ---------------------------------------------------------------------------------------------------------------------------- December 31,2001    Interest on Dismantaling Liability Dr.-----------2828 (56550*5%)    To dismantaling Liability------------------------2828 ---------------------------------------------------------------------------------------------------------------------------- December 31,2001    Lease Liability Dr--------------------------100000    To bank ---------------------------------100000 --------------------------------------------------------------------------------------------------------------------------- December 31,2001    Depreciation on ROU assets Dr.------------------60935    ROU assets ----------------------------------60935 ---------------------------------------------------------------------------------------------------------------------------- Working Note-1 calculation of lease liability = (100000* PVF @5% for 1-15 years) + ( 50000*PVF@5% for 15-20 year) =(100000*10.38)+ (50000*2.083) =1038000+104150=1142150 Working Note-2 Calculation of dismantaling liability =150000* pvf @5%, 20th year =150000*.377=56550 Working note-3 As the lease term is 20 year the rou asset to be depreciated over 20 year = 1218700/20 year=60935/ year.

2.Journal entry in the books of Lessor(Victory Laesing Co.)

january 01,2001 Machinery account Dr.-------1122095 To cash------------------------1122095 --------------------------------------------------------------------------------------------------------------- january 01,2001 Net investment in lease Dr------------------1122150 (pv of lease payment- direct cost of 20000)    To machinery Account-------------------1122095    To profit & Loss account----------------55 ------------------------------------------------------------------------------------------------------------------- December 31,2001 Net Invetsment in lease Dr.---------------- 56108    (1122150*5%)    To interest income on Net investment in leases---------56108 ---------------------------------------------------------------------------------------------------------------- December 31,2001 Bank account    Dr.---------------100000 To net investment in leases------100000 ------------------------------------------------------------------------------------------------------- Note- it is an finance lease as the lease term covers all the life period.