Question

Oshimbala Foods Ltd is a fast food company that operates many outlets across the country. The reporting period of Oshimbala Foods Ltd ends on 31 October. Oshimbala Foods Ltd is not registered as a VAT vendor.

MATTER 1

On 1 November 2014 Oshimbala Foods Ltd purchased equipment with an invoice price of N$ 273 600 under a lease agreement. The lease payments will consist of equal annual instilments over a period of 4 years, payable in arrears. The interest rate applicable on this lease agreement is 8% per year. All payments due have been paid on time each year. The equipment is depreciated on the straight line basis over 5 years with no residual value.

Required:

Disclose the long term borrowings note applicable to the lease liability in the Statement of Financial Position of Oshimbala Foods Ltd on 31 October 2016 in accordance with International Financial Reporting Standards. Note: Round disclosed amounts to the nearest Dollar.

MATTER 2

On 1 January 2016 Oshimbala Foods Ltd signed a 3-year rental agreement on a new outlet to be opened in Maruua Mall. The business was able to negotiate a very good deal on this 3-year rental agreement. For the first year of the agreement, Oshimbala Foods Ltd will not have to pay any rent on the outlet. In the second year of the contract, the business will pay N$ 2 500 rental per month and in the third (last) year of the agreement Oshimbala Foods Ltd will pay N$ 5 000 per month. The accountant of Oshimbala Foods Ltd did not recognize any entries in the accounting records of the business for the period ended 31 October 2016 since no payments had to be made during the first year of the agreement.

Required:

a) Explain whether the accountant of Oshimbala Foods Ltd was correct in not recording any journal entries on the rental agreement for the period ended 31 October 2016 in accordance with International Financial Reporting Standards.

b) Provide the journal entry (if any) to appropriately account for the rental agreement in the accounting records of Oshimbala Foods Ltd for the reporting period ended 31 October 2016.

(Total 30 MARKS)

Answer 1

Price of the equipment = N$ 273,600

Rate of interest = 8%

Period of repayment = 4 years

We have to find an anuuity which when discounted by 8% annualy over 4 years is equal to the price of the equipment.

273600 = PMT/1.08 + PMT/(1.08)^2 + PMT/(1.08)^3 + PMT/(1.08)^4

To solve for pmt with your financial calculator put PV = -273600 , I/Y = 8 , N = 4, FV = 0 and solve for PMT

To solve for pmt with excel type =pmt, select the function put r = 0.08, n = 4, pv = -273600, fv = 0

You will get pmt = 82606

Now we will prepare the amortization schedule for the lease payble

Date	Beginning balance	Interest expense	Payment	Principal repayment	Closing balance
31-Oct-15	273600	21888	82606	60718	212882
31-Oct-16	212882	17031	82606	65575	147307
31-Oct-17	147306.56	11785	82606	70821	76485
31-Oct-18	76485.0848	6121	82606	76485	0

interest expense = 0.08 x opening balance of the lease payble

principal payment = pmt - interest expense

closing balance = beginning balance - principal repayment

So the amount of long term liability note associated with the lease liability on 31st October , 2016 is N$ 147,307

Rent Expense problem

a) Rental agreement in itself is not an expense and dont record it till it is actually incurred but the yearly rental expense have to be recorded in the year incurred and not when payment is made. Even though Oshimbala Foods ltd didnt make any payment in the first year, it is clear they would be paying double the rent in the thrird years which basically means the rent expense for all the 3 years is N$2,500 per month.

As we follow accrual rule of accounting which means expenses are recorded in the period incurred and not necessarily when paid, the rent expense of N$ 2,500 per month have to be recorded for the 10 months of 2016 as well even though no payments have to be made in the current year.

So the account was incorrect in not recording any journal entries on the rental expense for the 10 months till 31st October, 2016.

b) Journal entry for the rental expense for the year is :

Date	Account	Debit	Credit
31-Oct-16	Rent expense	25000
	Rent payable		25000

So rent expense for all the three years would be N$ 2,500 per month.

Please like the solution if satisfied and drop a comment in case of any doubt.

Thankyou