Question

On 1 July 2019, BrixtonLtd entered into a five-year lease agreement with Reliable Finance Ltd for an item of machinery. Brixton Ltd incurred initial direct costs of $658 to negotiate and arrange the lease. The lease agreement requires BrixtonLtd to make five annual lease payments of $20,000 per year paid at the beginning of each year (in advance: annuity due) on 1 July with the first payment on 1 July 2019.

At the end of the lease term, BrixtonLtd will return the item of machinery to Reliable Finance Ltd. The item of machinery will then be sold by Reliable Finance Ltd. The residual value of the item of machinery at the end of the lease term is determined by Reliable Finance Ltd to be $8,000 of which $5,000has been guaranteed by BrixtonLtd. At the commencement of the lease, BrixtonLtd estimates that, at the end of the lease term, the item of machinery will realise $6,000 when it is sold.

The interest rate implicit in the lease is not determinable by BrixtonLtd. BrixtonLtd’s incremental borrowing rate is 3% per annum which reflects the fixed rate at which BrixtonLtd could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a five-year term, and with similar collateral.

Required

1. Can Brixton Ltd elect to take advantage of the exemption in paragraph 5 of AASB 16 Leases from recognising a lease liability and right-of-use asset at the commencement of the lease? Justify your answer.

2. Determine the amounts at which Brixton Ltd would recognise the right-of-use asset and the lease liability on 1 July 2019.                      

3. Prepare the appropriate journal entries to account for the lease by BrixtonLtd between 1 July 2019 and 1 July 2020.                                           

4. Determine the amount of the lease receivable to be recognised by Reliable Finance Ltd on 1 July 2019. Assume that Reliable Finance Ltd can readily determine the interest rate implicit in the lease which is 5%.                        

5. Explain why, on 1 July 2019, the amount of the lease receivable recognised by Reliable Finance Ltd is different from the amount of the lease liability recognised by Brixton Ltd.                                                                                    

f. Assume that, on 30 June 2021, BrixtonLtd revises its estimate of the amount that the item of machinery is expected to realise when it is sold at the end of the lease term from $6,000 to $4,000. How would this revision affect (1) the lease liability and (2) the right-of-use asset?                        

Answer 1