Question

Royals Incorporated leases a piece of equipment to Polar Corporation on January 1, 2020. The lease agreement called for annual rental payments of $8,648 at the beginning of each year of the 3-year lease. The equipment has a fair value of $35,000, a book value of $20,000, and an economic useful life of 5 years after which the residual value will be zero. Both parties expect a residual value of $12,500 at the end of the lease term, though this amount is not guaranteed. Royals set the lease payments with the intent of earning a 6% return, and Polar is aware of this rate. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

Instructions:

(Round all numbers to the nearest dollar.)

(a) Describe the nature of the lease to both Royals and Polar.

(b) Prepare the lease amortization schedule(s) for Polar for all 3 years of the lease.

(c) Prepare the journal entries for Polar for 2020 and 2021.

can you please solve this question as soon as possible. Thank you

Answer 1

a. Under IFRS 16, there is no distinction of operating lease and finance lease. All leases will be recorded on the balance sheet as liabilities, at the present value of the future lease payments, along with an asset reflecting the right to use the asset over the lease term.

However, considering the terms of the lease, this will fall under finance lease i.e Capital lease. The buyer as the option to purchase the asset at the end of the lease period, though it is not mandatory. The lease term extends to substantial economic life of the asset.

Present Value of lease payments
Annual lease payments	8648	Paid at the beginning of the year
Annuity factor	2.8334
Present value	24,503.24
Amortization of Lease liability	2020	2021	2022
Initial recognition/ opening balance	24,503	16,807	8,648
Less: lease payments at the beginning of the year	(8,648)	(8,648)	(8,648)
Balance	15,855	8,159	0
Add: Interest @6%	951	490	0
Closing balance	16,807	8,648	0
Amortization of Right of Use asset - On Straight line basis
Amortization of Lease liability	2020	2021	2022
Initial recognition/ opening balance	24,503	16,335	8,168
Less: Depreciation	(8,168)	(8,168)	(8,168)
Closing balance	16,335	8,168	-
1st year of lease		1-Jan-20
Entry for Lease recognition
Right of Use Asset Dr	24,503.00
Lease Liability Cr		24,503.00
Payment made to lessor		1-Jan-20
Lease Liability Dr	8648
Bank Cr		8648
Intererst on lease liability @ 6%	31-Dec-20
Interest payable Dr	951
Lease Liability Cr		951
Depreciation on Right of Use Asset - Straight line basis	31-Dec-20
Depreciation Dr	8,168
Right of Use Asset Cr		8,168
2nd year of lease
Payment made to lessor		1-Jan-21
Lease Liability Dr	8648
Bank Cr		8648
Intererst on lease liability @ 6%	31-Dec-21
Interest payable Dr	490
Lease Liability Cr		490
Depreciation on Right of Use Asset - Straight line basis	31-Dec-21
Depreciation Dr	8,168
Right of Use Asset Cr		8,168