Question

On 1 April 2019 Orange Limited entered into an agreement to lease a machine that had an estimated life of four years. The lease period is also four years, at which point the asset will be returned to the leasing company. Annual rentals of $50,000 are payable in arrears from 31 March 2020. The machine is expected to have a nil residual value at the end of its life. The machine had a fair value of $142,750 at the inception of the lease. The lessor includes a finance cost of 15% per annum when calculating annual rentals.

Required: How should the lease be accounted for in the financial statements of Orange Limited for the year end 31 March 2020? Note: Clearly present the lease liability table.

Answer 1

Journal Entry for Orange Ltd for the year ended 31st March 2020
Date	Accounts & Explanation	Debit	Credit
01-04-2019	Machinery Account	$   1,42,750
	Lease Liability Account		$   1,42,750
	(Being Machinery taken on Lease from Leasing company)
31-03-2020	Lease Liability Account	$       28,587
	Interest Expense Account	$       21,413
	Cash Account		$       50,000
	(Being Machinery taken on Lease from Leasing company)
31-03-2020	Depreciation on Machinery (leased asset)	$ 35,687.50
	Accumulated Depreciation Account		$ 35,687.50
	( Being depreciation on SLM basis of 4 years provided)
31-03-2020	Profit & Loss Account	$ 64,274.50
	Interest Expense		$ 35,687.50
	Depreciation on Machinery (leased asset)		$ 28,587.00
	( Being Interest & Depreciation transferred to P&L Account)

Calculation of Present Value of Lease Rentals Year Lease rental PV @15% Present value 1 $ 50,000 0.8696 $ 43,480 2 $ 50,000 0.7561 $ 37,805 3 $ 50,000 0.6575 $ 32,875 4 $ 50,000 0.5718 $ 28,590 Present Value of Lease Rentals $ 1,42,750 Present value of Lease Rentals is $ 142,750 which is equal's to Fair value of Asset $ 142,750 Calculation of Finance cost or Interest cost to be recognised by Lessee. Opening Finance Charge Principal Year Lease Rental Balance @15% Amount Paid 1 $ 1,42,750 $ 21,413 $ 50,000 $ 1,14,163 2 $ 1,14,163 $ 17,124 $ 50,000 $ 81,287 3 $ 81,287 $ 12,193 $ 50,000 $ 43,480 4 $ 43,480 $ 6,520 $ 50,000 $