Question

Customer Corp. entered into a five-year lease agreement with Supplier Ltd, on 1 July 2019. The lease is for a number of spa baths. Supplier Ltd acquired the spa baths on 1 July 2019, at the fair value of $1,009,850. Customer Corp. uses the spa baths at a club. The baths are expected to have an economic life of seven years, after which time they will have no residual value. There is a bargain purchase option that Customer Corps will be able to, and is expected to, exercise at the end of the fifth year, for $100,000.

There are to be five annual payments of $250,000, due at the end of each fiscal year (i.e., on 30 June each year). Customer Corp. is responsible for the insurance and maintenance of the equipment. The equipment is to be depreciated on a straight-line basis. The interest rate implicit in the lease is 10% per year. The lease can be cancelled by Customer Corp. upon payment of a penalty of $700,000.

REQUIRED:                                       

(1)    What type of lease is this for Supplier Ltd? Provide justifications for your classification considering the criteria in AASB 16 – ‘Leases’.

(2)    Prepare the journal entries, including narrations, for Supplier Ltd from 1 July 2019 to 30 June 2020 to record the lease arrangement consistent with AASB 16 – ‘Leases’.

(3) For Customer Corp. the contract contains a lease. Prepare the journal entries, including narrations, for Customer Corp. from 1 July 2019 to 30 June 2020 to record the lease arrangement consistent with AASB 16 – ‘Leases’

Answer 1

Ans 1: The type of lease for Supplier Ltd : Finance Lease.

As per AASB- 16 ‘Leases’: a lease is classified as finance lease when:

· the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;

· the lessee has the option to purchase the underlying asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception date, it is reasonably certain that the option will be exercised;

· the lease term is for the major part of the economic life of the underlying asset, even if title is not transferred

As it is mentioned in the question , the lessee will be given with bargain purchase option wherein if lessee will be able to, and is expected to, exercise purchase option at the end of the fifth year, for $100,000.

Also , lease is for 5 years and the life of asset is estimated to be of 7 years. Hence , majority life of asset is covered under lease.

Also, when we consider the cost of asset:

Fair Market of Asset at the inception of lease		$ 1009850
Present Value of lease payment at 10% cumulative factor for 5 Years	$250000* 3.790786	$ 947696.5
% of cost covered	93.85%

Ans 2 : Journal Entries for Supplier Ltd. from 1 July 2019 to 30 June 2020 to record the lease arrangement consistent with AASB 16 – ‘Leases’. (Answers given in round figure)

Date	Particulars	Debit	Credit
01st July, 2019	Lease receivable Account Dr.	$10,09,850
	Inventory Account		$10,09,850
	(Being asset is given on lease deducted from inventory at fair market value)
30th June, 2020	Cash at bank Account Dr.	$2,50,000
	Lease receivable Account		$1,49,015
	Interest Income Account		$1,00,985
	(Being rentals receivale for the first year of lease)
Calculation
	Lease rental	Interest	Principal	Balance Outstanding
				$10,09,850
1	$2,50,000	$1,00,985	$1,49,015	$8,60,835
2	$2,50,000	$86,084	$1,63,917	$6,96,919
3	$2,50,000	$69,692	$1,80,308	$5,16,610
4	$2,50,000	$51,661	$1,98,339	$3,18,271
5	$3,50,000	$31,827	$3,18,173	$99
** Assuming that lessee will excercis the purchase option

Ans 3 : Journal Entries for Customer Corp. from 1 July 2019 to 30 June 2020 to record the lease arrangement consistent with AASB 16 – ‘Leases’. (Answers given in round figure)

Date	Particulars	Debit	Credit
01st July, 2019	Lease Asset_ Bath Tubs	$9,47,697
	Leased Liability		$9,47,697
	(Being receivables from lease is accounted . Being Present value of 250000$ at 10% for five years)
30th June, 2020	Depreciation Expenses	$1,35,385
	Accumulated Depreciation		$1,35,385
	(Being depreciation is calculated on the asset,given cost 947697 and life of seven years)
30th June, 2020	Interest Expenses Account	$94,770
	Leased Liability	$1,55,230
	Cash at bank		$2,50,000
	(Being rentals receivale for the first year of lease)
Calculation
	Lease rental	Interest	Principal	Balance Outstanding
				$9,47,697
1	$2,50,000	$94,770	$1,55,230	$7,92,466
2	$2,50,000	$79,247	$1,70,753	$6,21,713