Question

On 1 July 2021 Fairval Ltd (the lessee) contracts a lease equipment for five years at an annual rental of $20,000, with the first payment payable immediately and subsequent annual payments due on 30 June. The equipment could have been purchased from the supplier for $80,747 on 1 July 2021 if leasing was not chosen instead. The rate of interest implicit in the lease is 12% and the end of the reporting period is 30 June. Assume the equipment is returned to the lessor at the end of the lease, when the residual value of the equipment is nil.

1)	Provide general journal entries to record the lease on 1 July 2021 for Fairval Ltd.
2)	Provide a schedule showing the division of the lease rental into interest and principal components for the lessee over the term of the lease.
3)	Provide the depreciation schedule for the lessee assuming the right-of-use asset is depreciated over the term of the lease (straight-line method).
4)	Prepare the general journal entries for the lessee for the remaining term of the lease (not covered by part (1) of this question) up until 30 June 2023.
5)	Based on the case, explain the motivation for the standard setter to release the new lease standard (AASB 16).

Answer 1

Part 1		20000	x 4.03735*	$        80,747
		* present value of $1 annuity due, n=5 year, i= 12%
	Date	Account titles and explanation	Debit	Credit
	Jul 1, 2021	Right of use assets	$80,747
		Lease liability( present value calculated )		$80,747
Part 2	Time	Lease Payment	Interest at 12% of lease liability/ROU	Principal	Lease Liability
	Jul 1, 2021				$        80,747
	Jul 1, 2021	$                                                                                          20,000		$        20,000	$        60,747
	Jun 30, 2022	$                                                                                          20,000	$        7,290	$        12,710	$        48,037
	Jun 30, 2023	$                                                                                          20,000	$        5,764	$        14,236	$        33,801
	Jun 30, 2024	$                                                                                          20,000	$        4,056	$        15,944	$        17,857
	Jun 30, 2025	$                                                                                          20,000	$        2,143	$        17,857	$                 -
Part 3	Depreciation per year = 80747/5 = 16149
	year	depreciation expense	Accumulated depreciation	carrying value
	0			80747
	1	16149	16149	64598
	2	16149	32298	48449
	3	16149	48447	32300
	4	16149	64596	16151
	5	16151	80747	0
Part 4	Date	Account titles and explanation	Debit	Credit
	Jul 1, 2021	Lease liability			$20,000
		Cash (Lease Payment)				$20,000
	Jun 30, 2022	Interest expense (12% x [$80,747 – 20,000])			$          7,290
		Lease liability (difference)			$        12,710
		Cash (lease payment)				$ 20,000
	Jun 30, 2022	Amortization expense ($80,747 ÷ 5Years)			$        16,149
		Right-of-use equipment				$ 16,149
	Jun 30, 2023	Interest expense (12% x [$80,747 – 20,000 - 12710])			$          5,764
		Lease liability (difference)			$        14,236
		Cash (lease payment)				$ 20,000
	Jun 30, 2023	Amortization expense ($80,747 ÷ 5Years)			$        16,149
		Right-of-use equipment				$ 16,149
Part 5	Motivation behind the setting new lease standard was bringing more transparency in leased assets and liability
	presentation, earlier in case of operating lease, no assets or liability was recognised which is now recognised.
	Now the lessee has to recognise assets and liability for the rights and obligation created by leases.
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