Question

ACCT Corp. is a manufacturer of truck trailers. On 1 January 2020, ACCT Corp. leased a trailer to a customer under a six-year lease agreement. The following information about the lease and the trailers is provided:

1. Equal annual payments of $10 816 are due on 31 December each year. The interest rate implicit in the lease is 8%.

2. The lease can be cancelled by the customer upon payment of a penalty of $40,000.

3. There is a purchase option that the customer will be able to exercise at the end of the sixth year, for $2 000. The estimated fair value of the trailer at the end of the sixth year is $10 000.

4. The fair value of the trailer is $51,260. The cost of a trailer to ACCT Corp. is $45,000. The trailer has an expected useful life of nine years.

REQUIRED:

(1) What type of lease is this for the lessor? Provide explanation and justification for your classification considering AASB 16.

(2) Prepare the journal entries for the lessor from 1 January 2020 to 31 December 2020 (the reporting period end of ACCT Corp.) to record the lease arrangement.

Answer 1

(1) Requirement 1:

The following facts are given in the question -

1. Annual Payment - $10,816  

2. Interest rate - 8%

3. Lease cancellation penalty - $40,000

4. Purchase option at the end of 6 years of lease. Amount to be paid for that - $2,000

5. Life of the trailer - 9 years

So, as per the facts provided, this is a financial lease. The reasons are -

1. There is a variable payment ($10,816) for the lease (depending upon the interest rate - 8% in this case).

2. In case the lease is cancelled, the person has to pay the penalty for it, which is $40,000 in this case.

3. Out of the maximum life (9 years in this case) the lease is given for a major time period that is 6 years.

4. There is a purchase option available at the end of the lease with the payment of $2,000.

For all the above mentioned reasons we come to the conclusion that this is a financial lease considering AASB16.

(2) Requirement 2: Journal Entry

Step 1 - Calculate present value

Present value of the trailer =   Lease payment amount + Lease payment amount *(1- (1+Interest rate) ^ (-No. of periods +1))/Interest rate

= 10816+ 10816* (1-( 1+ 8%) ^ (-6+1))/8%

= 53971.84

~ 53972.00

Step 2 – Calculate Interest Expense

Interest Expense = 53972 *8%

= 4317.76

~4318.00

Step 3 – Calculate Lease Liability Reduction

Total yearly lease payment = 10816

Calculated Interest = 4318

Net Liability reduction after payment on 31^st Dec’20 = 10816- 4318 = 6498.00

Step 4 – Calculate Depreciation

Depreciation per year = 53972/6 = 8995.33 ~ 8995.00

Step 5 -Journal Entry

Date	Particulars	Debit	Credit
01/01/2020	Equipment	53972
Lease Liability		53972
31/12/2020	Depreciation Expense	8995
Accumulated Depreciation		8995
31/12/2020	Interest Expense	4318
Interest Payable		4318
31/12/2020	Interest Payable	4318
Lease Liability	6498
Cash		10816