Question

Part A 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.

Part B Customer Ltd enters into a 10-year contract with Supplier Ltd for the right to use two specified physically distinct dark fibres within a larger cable connecting Hong Kong to Tokyo. Customer Ltd makes the decisions about the use of the fibres by connecting each end of the fibres to its electronic equipment (i.e., Customer ‘light’ the fibres and decides what data and how much data to transfer). If the fibres are damaged, Supplier Ltd is responsible for the repairs and maintenance. Supplier Ltd owns extra fibres but can substitute those for Customer Ltd’s fibres only for reasons of repairs, maintenance or malfunction.

REQUIRED: Determine whether the contract contains a lease. Please explain and justify your conclusion according to AASB 16.

Answer 1

A)B) Yes, the contract entered into between Customer Ltd.and Supplier Ltd. for obtaining the right to use two specified physically distinct dark fibres within a larger cable constitutes a 'lease'. The reason is that under AASB 16, a lease is any contract or its part thereof which gives the right to use an 'identified' asset for a particular time period for some consideration. Right to use means obtaining the right to direct and derive all the economic benefits from the use of such asset. In the given case, it is quite clear that Customer Ltd. has the decision-making power regarding the use of such fibres as well as what and how much data is to be transferred. Hence, Customer Ltd. has to recognise these rights as 'right-of-use' asset with a corresponding lease liability in accordance with AASB 16 irrespective of the fact whether such lease is a finance or operating lease.