HI6025 Accounting Theory and Current Issue

Tutorial 5
Accounting for Leases
Suggested Solutions

1.
SOLUTION

An amount of $15 000 to be paid in 10 years would be included as part of total lease
payments. It is the difference between what has been guaranteed ($50 000) and what
Customer Ltd believes the lease asset will be able to be sold for at the end of the lease ($35
000). The present value of this lease payment would be:
$15 000 × 0.6139 = $9209

2.
SOLUTION
Because Maroubra Ltd would be expected to exercise the option to acquire the machinery at
the end of the lease term—it is a ‘bargain purchase option’—then the present value of this
option would be included within the lease payments. Therefore the amount of the lease
liability to be recognised at the inception of the lease, and which is measured at present value,
is:

Up-front payment $20 000

Periodic lease payments $15 000 × 3.5460 $53 190

Bargain purchase option $30 000 × 0.8227 $24 681

Lease liability to be recognised at the inception of the lease $97 871

3 SOLUTION

From the appendices to this book, we know that the present value of an annuity of $1 in
arrears (‘in arrears’ means the amount is received, or paid, at the end of each year) for 10
years discounted at 10 per cent is $6.1446 (see the present value tables in the appendices).
The present value of $1 in 10 years, discounted at 10 per cent, is $0.3855. Hence, the present
value of the 10 payments of $3500 is $3500 multiplied by 6.1446, which equals $21 506, and
the present value of the unguaranteed residual is $771, which is $2000 multiplied by 0.3855.
The present value of the up-front payment of $4000 is not discounted. Therefore, using a rate

1
of 10 per cent for discounting purposes, the present value of the lease payments and the
unguaranteed residual is:

Present value of payment on 1 July 2019 $4 000

Present value of 10 yearly payments $21 506

Present value of unguaranteed residual $771

$26 277

The discounted value of $26 277 is the same as the fair value of the asset at lease inception.
Thus, 10 per cent is the implicit rate in this example. Note that some degree of trial and error
might be involved in determining the discount rate.

4.

Solutions:

To undertake this calculation, students may use trial and error. The implicit rate is 18%, proven as
follows:
Present value of initial payment $5000 x 1.0 = $5000
Present value of yearly payments ($5500 – $500) x 4.4941 = $22 470
Fair value at lease inception $27 470

Alternatively, and more easily, we can divide the liability on 1 July 2019 (which would exclude
the payment of $5000 at lease inception) by the periodic lease payments (after deducting the
executory costs) and then search for the appropriate interest rate within the present value
tables. This is easy because of the absence of a guaranteed residual or a bargain purchase
option.
(27 470 – 5000)  5000 = 4.494
A review of the present value of an annuity table shows that $4.4941 equals the present value
of an annuity in arrears of $1 per year, for 10 years, discounted at 18%.

2
5.
Solution
(a) The implicit rate is defined in the accounting standard as:

The rate of interest that causes the present value of (a) the lease payments and (b)
the unguaranteed residual value to equal the sum of (i) the fair value of the
underlying asset and (ii) any initial direct costs of the lessor

Bargain purchase options are included as part of the expected lease payments. In this
question the implicit rate is 12 per cent, proven as follows:
Periodic lease payments 315 000 x 3.6048 = 1 135 512
Bargain purchase option 280 000 x 0.5674 = 158 872
Fair value at lease inception 1 294 384

(b) 1 July 2019

Dr Leased asset 1 294 384

Cr Lease liability 1 294 384

30 June 2020
Dr Interest expense 155 326

Dr Lease liability 159 674

Dr Service expenses 35 000

Cr Cash 350 000

[155 326 = 1 294 384 x 0.12]

Dr Depreciation expense 180 731

Cr Accumulated leasehold depreciation 180 731
[180 731 = (1 294 384 – 210 000)/6]
Note that the useful life of the asset is used for depreciation purposes given the
existence of the bargain purchase options, which would result in the asset being
transferred to the lessee at the end of the 5-year lease.
30 June 2021
Dr Interest expense 136 165

Dr Lease liability 178 835

Dr Service expenses 35 000

Cr Cash 350 000

[136 165 = (1 294 384 – 159 674) x 0.12]

Dr Depreciation expense 180 731

Cr Accumulated leasehold depreciation 180 731

3
 (c)
30 June 2020 30 June 2021
Non-current assets
Leased asset $1 294 384 $1 294 384
Less accumulated depreciation $180 731 $361 462
$1 113 653 $932 922
Current liabilities
Lease liability $178 835 $200 295
Non-current liabilities
Lease liability $955 875 $755 580
The current portion of the lease liability ($178 835 in 2020, and $200 295 in 2021) is
the amount by which the lease liability will be reduced by the lease payments in the
following 12 months. In 2021 the current liability component would be calculated as:

$315 000 – [($1 294 384 – $159 674 – $178 835) x 0.12]
6.
Solutions:
(a) Present value of the lease payments:
(62 500 – 6250) x 3.6048 = 202 770
50 000 x 0.5674 = 28 370
Present value of minimum lease payments 231 140

Books of Sanders using the net method

1 July 2019
Dr Lease receivable 231 140

Dr Cost of sales 200 000

Cr Inventory 200 000

Cr Sales 231 140

30 June 2020
Dr Cash 62 500

Cr Service expenses recoupment (statement of 6 250

profit or loss and other comprehensive income)

Cr Interest revenue 27 737

Cr Lease receivable 28 513

[27 737 = 231 140 x 0.12]

4
 30 June 2021
Dr Cash 62 500

Cr Service expenses recoupment (statement of 6 250

profit or loss and other comprehensive income)

Cr Interest revenue 24 315

Cr Lease receivable 31 935

[24 315 = (231 140 – 28 513) x 0.12]

(b) Books of Gregory Ltd

1 July 2019
Dr Leased machinery 231 140

Cr Lease liability 231 140

30 June 2020
Dr Interest expense 27 737

Dr Lease liability 28 513

Dr Service expenses 6 250

Cr Cash 62 500

Dr Depreciation expense 33 020

Cr Accumulated leasehold depreciation 33 020

[33 020 = 231 140  7]

30 June 2021
Dr Interest expense 24 315

Dr Lease liability 31 935

Dr Service expenses 6 250

Cr Cash 62 500

Dr Depreciation expense 33 020

Cr Accumulated leasehold depreciation 33 020

[33 020 = 231 140  7]