Question

On 1 July 20x2, Large Mart signs a seven (7) year lease contract for a photocopier for its office. At the end of the lease period Large Mart will have the option to purchase the photocopier for $500 (but the expected fair value of the photocopier at the end of the lease term is $1,000). Large Mart is able to cancel the lease contract after paying 85% of the outstanding lease payments as a fine. Large Mart expects that the useful life of the photocopier is eight (8) years and all items in the Machinery/Equipment Account of Large Mart are depreciated using the sums-of-digits method. The photocopier is expected to have a residual value of $50 at the end of its useful life. The lease contract requires Large Mart to make the following payments: $10,000 when the contract is signed (1 July 20x2), and $1,000 at the end of each year (30 June) during the lease term. The Large Mart accounting department has determined that the interest rate implicit in the lease is 12%, and that the market price of the photocopier at the time the lease contract is signed is equal to $15,000. Required: a) Calculate the present value of the minimum lease payments AND outline the required calculations. b) Determine if the lease is a finance lease or an operation lease, and provide a DETAILED explanation of your decision. c) Provide all journal entries that are necessary in the books of Large Mart to account for the signing of the lease contract AND all lease payments that Large Mart makes during the financial year ended 30 June 20x3. d) State the amount of depreciation that will be recorded in the books of Large Mart for the year ended 30 June 20x3, assuming that Large Mart uses the sums-of-digits depreciation method AND outline the required calculations.

Answer 1

A. the present value of lease is

Time	cost (A)	Pvf@12% (B)	Value (A*B)
0	10000	1	10000
1 Year	1000	.892	892
2 year	1000	.797	797
3 Year	1000	.711	711
4 Year	1000	.635	635
5 Year	1000	.567	567
6 Year	1000	.506	506
7 Year	1000	.452	452

Total is rs.14560

B. Lease is finance lease because

• The asset transfers to the lessee at the end of the lease term
• The lessee has an option to purchase the asset from the lessor at below fair value
• The lease term is for a significant part of the asset’s useful economic life
• The present value of future lease payments amounts to substantially all of the asset’s fair value
• The leased asset is specialised in nature, and may only suit the needs of the lessee without major modification