Question

Question 2 Topic: Leases (for lessees) Answer both parts independently of each other.

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

Question 2:
Part A:
In the book of Lessee (Customer Ltd)

--> Calculation of Present value of asset (machinery)
Present value of the asset = Cash flow / (1+implicit rate)^{number of years}
Present value of the asset = $315,000 / (1+12%)⁵
Present value of the asset = $1,135,500

--> Calculation of Depreciation:
Depreciation = (Value of asset - Residual value) / Economic life of asset
= ($1,135,500 - $210,000) / 6
= $154,250
--> Calculation of interest expense:
Interest expense = Value of asset * Implicit rate
= $1,135,500 * 12%
= $136,260
Annual lease liability = Annual payment - Interest expense
= $315,000 - $136,260
= 178,740

Journal Entries:
(a)

Particulars	Debit	Credit
Gross asset (Machinery)	$1,135,500
To Lease liability		$1,135,500
Being lease of asset recognised in the book

(b)

Particulars	Debit	Credit
Depreciation Account	$154,250
To accumulated depreciation		$154,250
Being depreciation expense recorded

(c)

Particulars	Debit	Credit
Lease rental expense	$178,740
Interest expense	$136,260
To Cash		$315,000
Being lease and interest payment made

PART B:
As per AASB 16 in case of right to use asset for a limited period of time is termed as operating lease. In case of operating lease the repair and maintenance of the right to use asset lies with the lessor. In the present case the Customers limited enters in contract with Suppliers limited to use the physically distinct dark fiber connecting Honkong to Tokyo for the period of 10 years. And suppliers limited will repair the fibre in case of damage. The conclusion that the repair and maintenance expense lies with the lessor (Suppliers limited) is in conjugation with the provisions of AASB 16. Hence the conclusion derived in correct.