Question

Sullivan Ltd enters into a non-cancellable five-year lease agreement with Bubbles Ltd on 1 July 2015. The lease is for a number of spa baths that, at the inception of the lease, have a fair value of $924 560. The spas are being used as part of the amenities at Sullivan's exclusive Question 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 Sullivan Ltd will be able to an executive club, a club whose main clients are politicians exercise at the end of the fifth year, for $200 000. Bubbles Ltd manufactures spa baths. The cost of the spa baths to Bubbles Ltd is $800 000, with the result that Bubbles Ltd is making a profit on the sale of $124 560. There are to be five annual payments of $250 000, the first being made on 30 June 2016. Included within the $250 000 lease payments is an amount of $25 000 representing payment to the lessor for the insurance, sanitation, and maintenance of the equipment. The equipment is to be depreciated on a straight-line basis. The rate of interest implicit in the lease is 12 percent. PV of Annuity, 12%, n- 5 is 3.6048; PV of $1, n-5 is 0.5674 REQUIRED (a) Calculate the present value of the minimum lease payments. (b) Prepare the journal entries for the financial years ending 30 June 2016 and 30 June 2018 in the books of Bubbles Ltd, assuming Bubbles Ltd uses the net method.

Answer 1

	Ans. (a)	Computation of PV Minimum Lease Payment
		Year	Lease Payment	Discounted rate @12%	Discounted Lease Payment
		1	250000	0.892	223000
		2	250000	0.797	199250
		3	250000	0.712	178000
		4	250000	0.636	159000
		5	250000	0.567	141750
					901000
	Present Value of Minimum Lease Payment				249944.5

Ans. (b) Journal Entries in the books of Bubbles ltd

At the end of FY 30th Jun, 2016

Particulars Dr Cr

1. Bank Account Dr $250000

To Sullivan  Ltd Account $250000

2. Profit or Loss Account Dr $157080

To Depreciation Account (Spa Baths) $132080

To Insurance and Maintenance Account $25000

At the end of FY 30th Jun, 2018

1. Bank Account Dr $250000

To Sullivan  Ltd Account $250000

2. Profit or Loss Account Dr $157080

To Depreciation Account (Spa Baths) $132080

To Insurance and Maintenance Account $25000

Notes:

Calculation of Depreciation(SLM) = (Fair Value-Residual Value)/Useful Life

=($924560-$0)/7

=$132080