Question

‘X’ Ltd enters into a 5-year agreement to lease an item of machinery from ‘Y’ Ltd on 1 July 2019. ‘X’ Ltd incurred costs of $3928 in setting up the lease agreement. The machinery has a fair value of $492 000 at the inception of the lease and it is expected to have an economic life of 6 years, after which time it will have a residual value of $45 000. The lease agreement details are as follows:

Length of lease	5 years
Commencement date	1 July 2019
Annual lease payment, payable 30 June each year commencing 30 June 2020	$110,000
Residual value at the end of the lease term	$100,000
Residual value guarantee by ‘X’ Ltd	$60,000
Interest rate implicit in the lease	6%
The lease is cancellable without any penalties

All insurance and maintenance costs are paid by ‘Y’ Ltd and are expected to amount to $10 000 per year and will be reimbursed by ‘X’ Ltd by being included in the annual lease payment of $110 000. The machinery will be depreciated on a straight-line basis. It is expected that ‘X’ Ltd will return the machinery to ‘Y’ Ltd at the end of the lease.

Note:

Present Value Interest Factor of Annuity (PVIFA) for 6% 5 years is 4.2124 and Present Value Interest Factor (PVIF) for 6% 5 years is 0.7473.

Required:

1. Calculate the initial lease liability recongnised by ‘X’ Ltd to negotiate the lease agreement.

                                                                                                         

2. Prepare the journal entries to account for the lease in the books of ‘X’ Ltd for the year ending 30 June 2020.                                           

                                                                                                        

3. Prepare a schedule of lease receipts for ‘Y’ Ltd.                             

4. Prepare the journal entries to account for the lease in the books of ‘Y’ Ltd for the year ending 30 June 2020.                                                        

Answer 1

Solutions :-

a) Calculation Initial Lease Liability

110000×PVAF (5,6%) + 60000×PVIF (5,6%)

= $508202

b ) Journal Entries

i) Right to use Assets Account. Debit $508202

To lease liability account credit. $ 508202

ii) Depreciation account. Debit. $84700

To Right to use assets. Credit. $ 84700   

iii) Profit and loss account. Debit. $84700

To Depreciation. Credit. $ 84700

iv) Finance charges account. Debit. $48492

Lease liabilities account Debit. $ 61508

To Bank Credit. $ 110000

d) i) Lease Receivable account Debit $ 508202

To Revenue Account. Credit. $ 508202