Question

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2021 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement:

(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2021, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful.

Future Value of Ordinary Annuity of 1
Period	5%	6%	8%	10%	12%
1	1.00000	1.00000	1.00000	1.00000	1.00000
2	2.05000	2.06000	2.08000	2.10000	2.12000
3	3.15250	3.18360	3.24640	3.31000	3.37440
4	4.31013	4.37462	4.50611	4.64100	4.77933
5	5.52563	5.63709	5.86660	6.10510	6.35285
6	6.80191	6.97532	7.33592	7.71561	8.11519
7	8.14201	8.39384	8.92280	9.48717	10.08901
8	9.54911	9.89747	10.63663	11.43589	12.29969
9	11.02656	11.49132	12.48756	13.57948	14.77566
10	12.57789	13.18079	14.48656	15.93743	17.54874

	Present Value of an Annuity Due of 1
	Period		5%		6%		8%		10%		12%
	1		1.00000		1.00000		1.00000		1.00000		1.00000
	2		1.95238		1.94340		1.92593		1.90909		1.89286
	3		2.85941		2.83339		2.78326		2.73554		2.69005
	4		3.72325		3.67301		3.57710		3.48685		3.40183
	5		4.54595		4.46511		4.31213		4.16986		4.03735
	6		5.32948		5.21236		4.99271		4.79079		4.60478
	7		6.07569		5.91732		5.62288		5.35526		5.11141
	8		6.78637		6.58238		6.20637		5.86842		5.56376
	9		7.46321		7.20979		6.74664		6.33493		5.96764
	10		8.10782		7.80169		7.24689		6.75902		6.32825

If Alt accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2021?

Amortization Expense and Interest Expense

Interest Expense

Lease Expense

Amortization Expense

Answer 1

	Lessee Accounting: Alt Corporatiion
	The lease liability and the ROU asset are measured on the commencement date using the Implicit rate of interest or incremental borrowing rate(if implicit rate is not known)(i.e., 10% p.a. in this case) at lease commencement date . The lease liability is accounted for by the interest method subsequently and the ROU asset is subject to depreciation on the straight-line basis over the lease term of 3 year.
	The leasee shall record the lease liability (Present value of Lease payment & expected residual value, if guaranteed ) & right in use asset in the given case.
	Year	Payments (Cash flows)	Present Value Factor @10%p.a.	Discounted Cash flows/ Present value
	1	$                                                  574,864.00	1	$                             574,864
	2	$                                                  574,864.00	0.90909	$                             522,604
	3	$                                                  574,864.00	0.82645	$                             475,094
	Total	$                                                    1,724,592		1,572,562
	Lease Amortisation Schedule:
Year	Opening lease liability	Lease Payments	Interest Expense @ 8% per annum	Closing lease liability
	a	b	c=(a-b)*10%	d=a+c-b
1	$                            1,572,562	$                                                        574,864	$                     99,770	$                         1,097,468
2	$                            1,097,468	$                                                        574,864	$                     52,260	$                             574,864
3	$                                574,864	$                                                        574,864	$                             (0)	$                                        (0)
	Note: As the lease payment is being made at the beginning of the quarter, interest will be calculated on Opening lease liability less lease payment .
	Right in use asset Schedule: (Amortisation=$15,72,562/3 year= $524,187)
	Year	Opening	Depreciation	Closing
	1	$                                                    1,572,562	$                  524,187	$                         1,048,375
	2	$                                                    1,048,375	$                  524,187	$                             524,187
	3	$                                                        524,187	$                  524,187	$                                         -
		In the books of Leasee
a		Journal Entries
	Year	Particulars	Debit	Credit
	01-01-21	Right of Use Asset A/C	$               1,572,562
		To Lease liabilty A/C		$                         1,572,562
		(Being initially recognise the lease-related asset and liability .)
	01-01-21	Lease liabilty A/C	$                  574,864
		To Cash A/C		$                             574,864
		(To record lease payment)
	31-12-21	Interest expense A/C	$                     99,770
		To Lease liabilty A/C		$                               99,770
		(Being interest expense & lease liablity paid)
		($15,72,562-$574,864)*10%
	31-12-20	Amortisation expense A/C	$                  524,187
		To Right of Use Asset A/C		$                             524,187
		(To record depreciation expense on the ROU asset)
		($15,72,562/10 year)
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