Question

Question 4

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

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

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