Question

On 1 July, 2020 Bushman Ltd entered into a four-year lease of a building from Lessor Ltd. The terms of the lease agreement are as follows.

• Four payments of $200,000 are due starting on 30 June 2021 (after interest has accrued).

• Bushman can elect to terminate the lease at any time, but they need to pay 20% of an annual lease payment for administrative purposes upon termination

• The economic life of the building is estimated to be ten years.

• The fair value of the building at the commencement of the lease is $1,000,000.

• At the end of the lease term, Bushman has the option to purchase the building from

  Lessor Ltd at a price that is 10% lower than the predicted market value of the building

  at that time.

• The interest rate implicit in the lease is 5 per cent.

  Assume that the contract is a lease for the purposes of AASB 16 ‘Leases’.

  REQUIRED:

  Explain how Lessor Ltd would classify the lease in accordance with the requirements of AASB 116 ‘Leases’. Show all necessary working, explanations and assumptions to support your answer. Also prepare the necessary journal entries for the first year in the books of Lessor Ltd (i.e. 1 July 2020 to 30 June 2021).

Answer 1

Facts given about the lease-terms

1. The lease does not transfer ownership of the building to the lessee by the end of the lease term.

2.At the end of the lease term, Bushman , the lessee has the option to purchase the building from Lessor Ltd at a price that is 10% lower than the predicted market value of the building ,that time.

3.The economic life of the building is estimated to be ten years. & it is a four-year lease , so the lease is only for 4/10=40% & not for major part of the asset's economic life.

4.The present value of the lease payments at the inception of the lease amounts to $ 709190 (ie. $ 200000*3.54595----P/A,i=5%,n=4 yrs.) which is--709190/1000000= 70.92% of the fair value & not substantially all of the fair value of the building.

5. Nothing is said about the specialised nature of the building, that only the lessee can use it.

6.Bushman,the lessee can elect to terminate the lease at any time, but they need to pay 20% of an annual lease payment for administrative purposes upon termination--- ie. The lessor's losses due to cancellation are borne by the lessee.

As per AASB 16 for Leases, even if any one of the above conditions are met , the lessor need to classify the lease as a FINANCE LEASE & account it as such , in his books.

In this case, more than 1, ie.conditions 2& 6 are met.

so, the Lessor Ltd. Should classify the lease as a FINANCE LEASE.

Lease Amortisation Table

Year	End Of Year lease pmt.	Tow. Int.	Tow. Lease	Lease Receivable
1	2	3=Prev.5*5%	4=2-3	5=Prev.5-Current 4
0				709190
1	200000	35460	164540	544650
2	200000	27232	172768	371882
3	200000	18594	181406	190476
4	200000	9524	190476	0
		90810	709190

	Lessor Journal entries
July 1,2020	Lease receivable	709190
	Building		709190
Dec 31,2020	Interest receivable	17730
	Interest revenue		17730
	(35460/2)
Jun 30,2021	Cash	200000
	Interest receivable		17730
	Lease receivable		164540
	Interest revenue		17730