Question

GI has given the machinery on lease to BD Co for extraction of minerals. The lease started on 1^st January 2020 and would end on 31.12.2021. The lessor has classified the lease as capital lease. The implicit rate for GI is 10%p.a. The annual lease rental is 75,000 payable at the start of each year. GI has provided you the following amortisation schedule for its lease.

Date	Lease Rental	Interest (10%)	Principle	Closing Bal
01.01.2020				205,166
01.01.2020	75,000	-	75,000	130,166
31.12.2020	75,000	13,017	61,983	68,183
31.12.2021	75,000	6,818	68,183	0

Required

1. Complete the amortization schedule above
2. What is the lease value ?
3. How much are the annual rentals?
4. Pass the journal entries in the books of Lessor ( GI ) to record the lease and receipt of first installment on 1.1.2020

Answer 1

In case of a capital lease(also termed as finance lease), the Lessee gains control over the asset and it similar to a financing agreement between lessee and lessor where the lessor provides a loan to the lessee for purchase of an asset. In this kind of lease, the Lessor de-recognizes the asset from his books and recognizes a lease receivable asset. The amount in which the liability and asset are recognized is arrived at by computing the present value of the lease payments discounted using the implicit rate.

The value for initial Recognition can be calculated as:

Date	Cash Flow	Discounting Factor @ 10%	Equivalent Cash Flows
01-01-2020	75,000	1	75,000.00
31-12-2020	75,000	0.90909	68,181.75
31-12-2021	75,000	0.82645	61,983.75
		TOTAL	205,166

Therefore the lease will initially be recognized at $ 205,166.

The amortization table can be drawn as below:

Date	Lease Rental	Interest @ 10%	Principal	Closing Balance
01-01-2020				2,05,166
01-01-2020	75,000	-	75,000	1,30,166
31-12-2020	75,000	13,017	61,983	68,183
31-12-2021	75,000	6,818	68,183*	-

* $1 adjusted for rounding off.

The first payment is made at the beginning of the lease period. Hence there is no interest payment included. For the remaining periods, the interest portion can be calculated as 10 % of the previous year's closing balance.

There for Payment 1, Interest = 0

For payment 2, Interest = 130,166 x 10% = $13,017

For payment 3, Interest = 68,183 x 10% = $ 6,818

Annual Lease rentals are $ 75,000 payable at the beginning of each year.

Following are the Journal Entries as on 01-01-2020:

Date	Particulars	Debit $	Credit $
01-01-2020	Lease Receivable a/c	205,166
	To Machinery		205,166
	(being the machinery transferred to BD Co on capital lease and corresponding lease receivable asset recognized)
01-01-2020	Cash a/c	75,000
	To Lease Receivable a/c		75,000
	(being the first installment of lease payments received)