Question

Supply Ltd entered into a non-cancellable five-year lease arrangement with Customer Ltd on 1 July 2019. The lease is for an item of machinery. There are to be five annual payments of $315 000, the first being made on 30 June 2020. The implicit interest rate is 12%. The Machinery is expected to have an economic life of six years, after which time it will have an expected residual value of $210 000. There is a bargain purchase option that Customer Ltd will be able to exercise at the end of the fifth year for $280 000. Customer Ltd determined that this contract contains a lease. REQUIRED: Prepare the journal entries in the books of the lessee (Customer Ltd) from 1 July 2019 to 30 June 2020 (the end of the reporting period). Show all working.

Answer 1

Year	PV factor @ 8%	Remarks
1	0.89286	= 1 / 1.12
2	0.79719	= 0.89286 / 1.12
3	0.71178	= 0.79719 / 1.12
4	0.63552	= 0.71178 / 1.12
5	0.56743	= 0.63552 / 1.12
Total	3.60478

			Amount	Multiply: PV factor	Present value
Lease payment			315,000	3.60478	1,135,506
Bargaining purchase option			280,000	0.56743	158,880
Present value of minimum lease payments					1,294,386

Customer Ltd (Lessee)
Lease Amortization Schedule
Date	Annual Lease Payment	Interest on Liability	Reduction of Lease Liability	Lease Liability
1 July 2019				$   1,294,386
30 June 2020	$     315,000	$     155,326	$   159,674	$   1,134,712
30 June 2021	$     315,000	$     136,165	$   178,835	$      955,878
30 June 2022	$     315,000	$     114,705	$   200,295	$      755,583
30 June 2023	$     315,000	$       90,670	$   224,330	$      531,253
30 June 2024	$     595,000	$       63,747	$   531,253	$                   0
Total	1,855,000	560,614	1,294,386
Last year's interest adjusted = 595000-531253

Interest on Liability = Beginning Lease Liability * 12%

Reduction of Lease Liability = Annual Lease Payment Plus BPO - Interest on Liability

Lease Liability = Beginning Lease Liability - Reduction of Lease Liability

Bargain purchase option will reasonably certain to exercise.

Thus, right of use assets amortized over life.

Date	Accounts titles and explanation		Debit	Credit
1 July 2019	Right of use Asset		1,294,386
	Lease liability			1,294,386
	(To record the lease)
30 June 2020	Interest expense		155,326
	Lease liability		159,674
	Cash			315,000
	(To record lease payment.)
30 June 2020	Amortization Expense		215,731
	Right of use Asset			215,731
	(To record amortization expense.) (1294386/6)

Lease liability is also known as lease payable.