Question

Farm Ltd ]eases some parce]s of ]and from their owner for a period of 10 years at a time. The ]ease agreement can be cance11ed, but a significant pena1ty wi11 be incurred by Farm Ltd. The ]ease payments required inc1ude a payment up-front of $300 000, fo11owed by another 9 payments of equa] va]ue at the end of every year up to the end of the ninth year. The imp1icit rate in the ]ease is 10%. PV of 9 payments at 10% is 5.7590. Required Prepare the journa] entries for first three years for Farm Ltd to recognise the ]ease inc]uding for amortisation of ]ease. You can workout ]ease payments schedu]e in your notes and is not required as part of response.

Answer 1

Calculation of Present Value of Lease payments:

The present value of Lease payments is the aggregate of 300,000 paid upfront and the present value of subsequent 9 payments.

Year	Cash flow	Discounting Factor	Present Value
0	300,000	1	300,000
1-9	300,000	5.7590	17,27,700
		TOTAL	2,027,700

Present Value of Lease Payments = $ 2,027,700

note: In the books of the lessee, a Right-of-Use asset (ROU asset) will be created at the inception of a lease and a corresponding lease liability will also be created. The amount to be recognized is the present value of lease payments. The Implicit rate of return will be used for discounting the cash flows to its present value.

Hence at inception, the following Journal entry will be recorded:

Right-of-Use Asset	2,027,700
To Lease liability		2,027,700
(Being the ROU asset and lease liability recognized at the inception of the lease)

Lease Liability amortization table:

Year	Opening Balance	Finance Cost @ 10%	Net Balance	Less: Payments	Closing Balance
0	2,027,700	-	2,027,700	300,000	1,727,700
1	1,727,700	172,770	1,900,470	300,000	1,600,470
2	1,600,470	160,047	1,760,517	300,000	1,460,517
3	1,460,517	146,052	1,606,569	300,000	1,306,569
4	1,306,569	130,657	1,437,226	300,000	1,137,226
5	1,137,226	113,723	1,250,949	300,000	950,949
6	950,949	95,095	1,046,044	300,000	746,044
7	746,044	74,604	820,648	300,000	520,648
8	520,648	52,065	572,713	300,000	272,713
9	272,713	27,287	300,000	300,000	-

The above table shows the amortization of the lease liability over the lease period. The following journal entries will be passed for the same:

Particulars	Debit $	Credit $
Lease Liability A/c	300,000
To Cash		300,000
(Being the upfront lease payment made)
Finance cost A/c	172,770
To Lease liability		172,770
(Being the finance cost for the first year recognized at the end of year 1)
Lease Liability A/c	300,000
To Cash		300,000
(Being the 2nd payment made at the beginning of 2nd year)
Finance cost A/c	160,047
To Lease liability		160,047
(Being the finance cost for the second year recognized at the end of year 2)
Lease Liability A/c	300,000
To Cash		300,000
(Being the 3rd payment made at the beginning of 3rd year)
Finance cost A/c	146,052
To Lease liability		146,052
(Being the finance cost for the third year recognized at the end of year 3)

The ROU asset initially recognized will be depreciated on a straight-line basis over the lease term.

Annual depreciation = Value of ROU asset at the beginning / Lease Term

= 2,027,700 / 10

= 202,770

Therefore, in order to depreciate the ROU asset, the following entry will be passed at the end of each year.

Depreciation A/c	202,770
To Accumulated Depreciation on ROU asset		202,770
(Being the annual depreciation on ROU asset)