Question

ABC company leased new advanced computer equipment to STU Ltd on 1 January 2019.STULtd has to pay annual rental of $290,000 starting at 1 January 2019. It is a four years lease with ultimate rental payment failing on 1 January 2022. At the end of lease term, STU Ltd has the option of purchasing the computer equipment for $20,000, and it is highly probable that STU Ltd will exercise such option. On the other hand, , STU Ltd will guarantee to Equipment Ltd a residue value of $160,000, Also, STU Ltd has to pay insurance cost, repair and maintenance expenditure on the computer equipment. Before the execution of lease, STU Ltd paid $16,500 as legal service fee and $32,500 to intermediates as negotiation of lease term and condition.

The equipment has an expected useful life of 5 years, while STU Ltd purchase the computer equipment from the market, the cash price is $1,160,000

The market borrowing rate at commencement of lease is 11%

Required

1. In ABC company’s point of view, explain and determine whether the above

   arrangement is finance or operating lease.

2. Assume the lease is a finance lease, prepare journal entries of STU Ltd for the financial year ended 31 December 2019

3. Prepare the extract of Statement of profit or loss and other comprehensive income and Statement of Financial Position to report the lease forABC company for the financial year ended 31 December 2019

Answer 1

For the year ending Dec. 31, 2019

Solution (a)	The arrangement is Finance lease
	Reasons
	(1) Lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise at $ 20000
	(2) Lease term (4 years) is for a major part of the remaining economic life( 5 years) of the underlying asset
	(3) The present value of the lease payments (working-1)and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value ( $ 1160000) of the underlying asset
	Working-1
	Calculation of present value of lease payments
		Amount
	1st lease payment at beginning of the year	290000
	present value of next 4 lease payment (290000*3.1024)	899696
	legal services fee	16500
	payment for negotiation of lease	32500
	Total lease payments	1238696
Solution (b)	Journal entries
Date	Account name	Debit	Credit
Jan. 1, 2019	Lease assets	1238696
	ABC company -Lease Payable		1238696
	(record the equipment taken on lease)
	ABC company -Lease Payable (290000-136257)	153743
	Interest expense (1238696*11%)	136257
	Cash		290000
	(record the payment of lease)
Dec. 31, 2019	Statement of profit	445931
	Interest expense		136257
	Amortization expense (1238696/4)		309674
	(record the expenses charged to income statement)
Solution (c)	(1) Extract of statement of profit
	Interest expense	136257
	Amortization expense	309674
	Total	445931
	(2) Other comprehensive income	NIL
	(3) Statement of financial positions
	Assets
	Lease assets	929022
	Liabilities
	ABC company- lease payable	1084953