Question

ACCOUNTING FOR LEASES
  This equipment is NOT considered a specialized one.
  Start Date: January 1, 2020
  Contract term: 3 years (The contract ends on December 31, 2022.) The property title will be transferred to the tenant free of cost when the third year ends.
  Annual payments: $ 37,174 payable on January 1 of each year. The first payment was made on 1/1/20.
  Estimated useful life for the asset: 4 years.
  Estimated residual value: zero.
  Landlord's interest rate: 12%, the tenant does NOT know it.
  Lessee's incremental borrowing rate: 10%.
  The fair value of the asset is $ 100,000.
  The original acquisition cost the lessor paid for the equipment was $ 90,000.

  REQUIRED (Read carefully and only answer what is asked, otherwise you may lose points)
  1. Prepare the journal entries to be recorded by the LESSEE on January 1, 2020.
  2. Indicate the expense accounts and the amount that the lessee will report in the 2020 statement of income and expenses (account and amount).

Answer 1

Solution 1.

Journal Entry at the lease commencement date
Date	Particulars	Debit	Credit
01-01-20	Right of use Asset A/c Dr.	100,000
	To Lease Liability A/c		100,000
	(Being entry for recording of lease transaction at commencement date)

Solution 2.

Following accounts will be charged to Statement of Income and Expense

Interest expense of $ 7539 (See working below)

Depreciation expense of $ 25000 (100000/4 year)

Notes and Workings

IFRS 16

It is the case of finance lease as title of property will be transfered to tenant free of cost at the end of third year.

As of the commencement date of a lease, the lessee measures the liability and the right-of-use asset associated with the lease. These measurements are derived as follows:

a. Lease liability. The present value of the lease payments, discounted at the discount rate for the lease. This rate is the rate implicit in the lease when that rate is readily determinable. If not, the lessee instead uses its incremental borrowing rate.

b. Right-of-use asset. The initial amount of the lease liability, plus any lease payments made to the lessor before the lease commencement date, plus any initial direct costs incurred, minus any lease incentives received.

Rate Implicit in the lease	12%
Year	Cash Flow	Discounting Factor	Discounted Cash flows
0	37,174	1.0000	37,174
1	37,174	0.8929	33,191
2	37,174	0.7972	29,635
			100,000

Rate implicit in lease is the rate at which present value of lease payments = Fair value of leased asset

i.e 100000 = PV @ rate (37174 Year 0 , 1 , 2 )  

100000 = 1*37174 + [1/(1+r)^1]*37174 + [1/(1+r)^2]*37174

Thus r = 12%

Year	Opening	Interest	Lease payment	Closing
1	62,826	7,539	37,174	33,191
2	33,191	3,983	37,174	0
3	0	0	-	0

Since lease payment are made at the begining of the year, year 1 lease payment is considered at year 0 lease payment and so on.