Question

In: Accounting

On 1 January 2010 Sleepless Ltd purchased 2 factory buildings one in Independence street and another...

On 1 January 2010 Sleepless Ltd purchased 2 factory buildings one in Independence street and another in Mandume Ndemufayo Road, for N$250 000 each. Both factory buildings were initially to be used to manufacture beds for sale to retail stores. The buildings are not specialised and could be used for a variety of manufacturing processes. The estimated useful life of each building is 15 years with no residual value.

Sleepless Ltd lost a major customer effective 1 January 2015 and as a result, had surplus factory space for their requirements. Sleepless Ltd enters a contract to lease the factory building in Mandume Ndemufayo road to a tenant with a commencement date of 1 January 2015. The lease term is 5 years. The rental payments are N$100 000 per year, payable annually in arrears and are to be increased by 20% per year over the lease term. The buildings will revert to Sleepless Ltd at the end of the contract.

Sleepless Ltd holds all investment property under the cost model.

Required:

1.1 Discuss briefly whether Sleepless Ltd should classify this lease contract as a finance

or operating lease.

1.2 Record journal entries of the factory building in Mandume Ndemufayo Road for 20 the year ended 31 December 2015,2016,2017,2018 and 2019.

Solutions

Expert Solution

Sol :

1.1

The difference between a finance lease and an operating lease lies in whether the risks and rewards incidental to ownership of the leased asset are transferred from the lessor to the lessee. Risks and rewards are considered not to be transferred if:

  1. The lease term is not major portion of the useful life of the asset;
  2. The present value of lease payments does not make substantively all the fair value of the leased asset;
  3. The leased asset is not tailor-made for the lessee but is of general nature such that it can be leased out to another party by the lessor; and
  4. The ownership of the leased asset does not transfer to the lessee at the end of the lease term   

The lease should be treated as an operating lease because:

  1. It does not transfer the ownership to lessee at the end of the lease term;
  2. The lease term is only half the total useful life of the asset; and
  3. There is no bargain purchase option (i.e. option to buy the asset at lower price at the end of the lease term).

1.2

Journal entry for the year ended 31.12.2015

Lease Rentals Receivable $100,000

To Lease Rental Income $100,000

Journal entry for the year ended 31.12.2016

Lease Rentals Receivable $120,000

To Lease Rental Income $120,000

Journal entry for the year ended 31.12.2017  

Lease Rentals Receivable $144,000

To Lease Rental Income $144,000

Journal entry for the year ended 31.12.2018

Lease Rentals Receivable $172,800

To Lease Rental Income $172,800

Journal entry for the year ended 31.12.2019

Lease Rentals Receivable $207,360

To Lease Rental Income $207,360

ekkarill92 answered 1 year ago
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