Question

On 1 January 2020, Lessee Ltd entered into a two-years lease with Lessor Ltd for a equipment. The contract contains an option to extend the lease term for a further a year. Lessee Ltd ascertained that it is reasonably certain to exercise this option. The equipment has a useful economic life of 10 years.

Lease payments are $25,000 per year for the initial term and $45,000 per year for the period when the option is exercised. All payments are due at the end of the year (i.e. 31 December). To obtain the lease, Lessee Ltd incurs initial direct costs of $12,500 on 1 January 2020. The interest rate within the lease is not readily determinable. Lessee Ltd s incremental rate of borrowing is 5%. Assume the initial direct cost was paid by Lessee Ltd to third party rather than to Lessor Ltd.

Required:
a. Calculate the initial carrying amount of the lease liability and the right-of-use asset

and prepare the relevant double entries on 1 January 2020.

b. Prepare extracts from the financial statements of Lessee Ltd in respect of the lease agreement for the year ended 31 December 2020.

Note: amortization table is required to show

c. Comment the accounting treatment of lease payment in lessee’s book if the lease term is less than 12 months

Answer 1

As none of the condition for finance lease is met the given lease is an operating lease for lessee.

a.

Working -

lease liability calculation
PV of lease payments
	$	PVF @ 5%	Present value
Year 1	$    25,000	0.9524	$           23,810
Year 2	$    25,000	0.9070	$           22,676
	Total		$           46,485
Right of use asset
PV lease payment	$    46,485
Initial direct cost	$    12,500
Right of use asset	$    58,985

Answer: -

Initial carrying amount of
Lease liability	$    46,485
Right of use asset	$    58,985

Date	Particulars	Debit $	Credit $
1st Jan 2020	Right of use asset	$    58,985
	Lease liability		$    46,485
	Cash		$    12,500

b.

working -

Lease expense	Interest @ 5%	Amortization of ROU lease asset asset portion	Balance
			$           46,485
$                   25,000	$      2,324	$                22,676	$           23,809
$                   25,000	$      1,190	$                23,810	$                    -

Amortization of ROU asset
	Initial direct cost amortization over lease term ($12,500/2)	Amortization
$    22,676	$                  6,250	$           28,926
$    23,810	$                  6,250	$           30,060

In the Books of lessee
Financial statement as on 31st Dec, 2020
Assets	$	Liabilities	$
Non current assets		Non current liability
Right of use asset	$    58,985	Lease liability	$      46,485
Less Amortization	$    28,926	Add Interest	$        2,324
Carrying value	$    30,060	Less lease payment	$    (25,000)
		Carrying value	$     23,809

c.

For lease with term less than 12 months,

Lessee may elect not to apply the recognition requirement for operating lease and hence lesse will recognize the lease payments on income statement on a straight line basis over the lease term.

For any clarification, please comment. Kindly Up Vote!