Question

On 1 July 2019, Cars Limited signed a 7-year non-cancelable lease for equipment that requires equal rental payment of $3,500,000 at the beginning of each year. The equipment has a fair value at the inception of the lease of $15,000,000, an estimated useful life of 10 years and no residual value. The lease does not transfer title or contain a bargain-purchase option. The Cars Limited’s incremental borrowing rate is 15% and PVIFA (n=7, i=15%) is 4.1604.

Required Indicate and explain the type of lease Cars Limited signed in 2019. Include a separate analysis for the scenarios where Cars Limited is the lessee and lessor.

Answer 1

The transaction should be considered as Operating Lease because

1. Term of lease is less than the life of the asset.

2, The lease does not transfer title or contain a bargain-purchase option.

If Cars Limited is a Lessee

The entity has to record the $3,500,000 lease rentals as operating expenses during the year and needs to be expensed of to profit and loss acount.

If Cars Limited is a Lessor

The entity has to charge depreciation of $1,500,000 for 2019 and written down value of equipement will be $13,500,000.

The entity has to book $3,500,000 as lease rental income for 2019.