Question

On January 2016, Profit Ltd enters the contract with City Ltd for the use of a truck. The contract contained the following clauses:

Lease term: four years with a $6,000 purchase option at the end of the lease.

Lease payments: $200,048 per annum in advance, the first payment is made on 1 January 2016.

Fair value of the truck : $720,000

Profit Ltd incurs $50,000 initial direct cost, including $15,000 legal fees and $35,000 commission to real estate agent

At the end of the lease, Profit Ltd has express intention to exercise the purchase option.

Implicit interest rate: 8%

Estimated useful life of the truck is five years

Profit Ltd accounts for its lease using IFRS 16

(a) Determine the lease liability and initial measurement of a right-use-use asset (i.e. the truck) for Profit ltd.

(b) Prepare the lease liability movement schedule for each year for Profit Ltd.

(c) Prepare accounting journal entries for Profit Ltd for the years ended 31 December 2016 and 2017

Answer 1

a) Lease liability for Profit Ltd. will be equal to sum of present value of all lease payments and present value of purchase option which is calculated as follows:-

Lease Liability = PV of Annual Lease payments+PV of Purchase Option

= [$200,048+($200,048*PVAF(3 yrs, 8%)]+[$6,000*PVF(4 yrs, 8%)]

= [$200,048+($200,048*2.5771)]+($6,000*0.735)

= $200,048+$515,544+$4,410 = $720,002

Therefore the lease liability is $720,002

Right of Use Asset will also include direct cost, legal fees and commission to real estate agent along with lease liability.

Right of use Asset = Direct Cost+Legal Fees+Commission to Real Estate Agent+Lease Liability

= $50,000+$15,000+$35,000+$720,002 = $820,002

b) Lease Liability Movement Schedule for Profit Ltd. (Amounts in $)

Date	Opening Bal (A)	Lease Payment (B)	Interest Expense (C = A*8%)	Decrease in Lease Liability (D = B - C)	Ending Bal (A - D)
01/01/16	720,002	200,048	0 (first lease payment at the beginning)	200,048	519,954
01/01/17	519,954	200,048	41,596	158,452	361,502
01/01/18	361,502	200,048	28,920	171,128	190,374
01/01/19	190,374	200,048	15,230	184,818	5,556
01/01/20	5,556	0	444	0	6,000

c) Journal Entries for Profit Ltd. (Amounts in $)

Date	Account Titles and Explanations	Debit	Credit
01/01/16	Right of Use Asset	820,002
	Cash		100,000
	Lease Liability		720,002
01/01/16	Lease Liability	200,048
	Cash		200,048
12/31/16	Interest Expense	41,596
	Interest Payable		41,596
12/31/16	Depreciation Expense ($820,002/4 yrs)	205,000.50
	Right of Use Asset		205,000.50
01/01/17	Interest Payable	41,596
	Lease Liability	158,452
	Cash		200,048
12/31/17	Interest Expense	28,920
	Interest Payable		28,920
12/31/17	Depreciation Expense ($820,002/4 yrs)	205,000.50
	Right of Use Asset		205,000.50