Question

ACCT Corp. is a manufacturer of truck trailers. On 1 January 2020, ACCT Corp. leased a trailer to a customer under a six-year lease agreement. The following information about the lease and the trailers is provided: 1. Equal annual payments of $10 816 are due on 31 December each year. The interest rate implicit in the lease is 8%. 2. The lease can be cancelled by the customer upon payment of a penalty of $40,000. 3. There is a purchase option that the customer will be able to exercise at the end of the sixth year, for $2 000. The estimated fair value of the trailer at the end of the sixth year is $10 000. 4. The fair value of the trailer is $51,260. The cost of a trailer to ACCT Corp. is $45,000. The trailer has an expected useful life of nine years.

REQUIRED: (1) What type of lease is this for the lessor? Provide explanation and justification for your classification considering AASB 16.

(2) Prepare the journal entries for the lessor from 1 January 2020 to 31 December 2020 (the reporting period end of ACCT Corp.) to record the lease arrangement.

Answer 1

As per AASB 16- A lessee must recognised the lease in its books as an asset and libility for all leases above 12 months. The lessee must recognize the machine as an asset in its books of accounts and depreciation and interest paymnets as an liability in the books.

A lease could either be operating lease for financing lease.

Finance lease:

1. If the lessor substantially transfers all the risk and reward related to the asset to the lessee it is a finance lease.

2. The lesse must have a right to purchase the asset at the end of the lease period and has control of the asset during the major part of its economic life.

3. The present value of lease payments must be substantially equal to the fair value of the asset.

4. If the lease is cancelled before maturity then the loss of cancellation is borne by the lessee.

Here, as all the risk and reward have been transfered to the lessee, the asset is retained for the major economic life of the asset (that is 6 yrs out of 9 yrs), the lessee has a right to purchase the asset at the end of the term of lease and as the present value of lease payments is substanitally equal/more than the fair value of the asset, it is an finance lease.