Question

How you recommend the client record the following lease:

The AP the prospective client, has entered into a 10- year contract to lease an entire building commencing on January 1, 2019. The agreement has a one 5 year -renewable option at the client’s discretion. The client is reasonably certain to exercise the 5-year renewal option.

Lease payments are $100,000 annually with a 2% escalation on January 1 st of each year.

The lease does not permit tenant improvements, early access or free rent.

There is no stated interest rate in the contract and the prospective client has determined its incremental borrowing rate is 4%.

Answer 1

Sol:

1. We recommend the client to treat the lease as operating lease since the asset is building and the life of asset cannot be determined.

2. Since the client recognises the lease as operating lease, he should treat the annual lease receipts as income in his books.

3. Entries will be like :

-> Bank a/c Dr $ 100000

To Lease receipts a/c $100000

(Being entry made for 1st year lease receipts received)

-> Bank a/c Dr $ 102000

To Lease receipts a/c $ 102000

(Being lease receipts received after proving 2% escalation for 2nd year)

The entries will be like this way by giving 2% yearly escalation till the end of the contract I.e., 5 years or 10 years based the renewal of the contract by the lessee.