Financial Reporting

Question

On 1 July 2019 GFD Ltd entered in a leasing contract with FCS Ltd for the rental of a machine for four years. At that date the useful economic life of the machine was six years. GFD Ltd is expected to obtain substantial economic benefits from the use of the machine and the firm is also expected to be able to direct the use of the asset during the lease term. The machine will be returned by GFD Ltd to FCS Ltd at the end of the lease term. Lease payments are Rs1,200,000 per annum, payable at the end of each financial year during the lease term. The financial year of GFD Ltd and FCS Ltd ends on 30 June of each year. GFD Ltd will pay the lease amount through bank transfer. The rate implicit in the leasing contract is 10% and the annuity factor at a discount rate of 10% for four years is 3.170. The market price of the machine at 1 July 2019 was Rs4,000,000. GFD Ltd incurred initial direct costs of Rs150,000 to obtain the lease.

Required

(i)                Calculate the amount at which the right of use asset should be recorded in the books of GFD Ltd at 1 July 2019.                                   

(ii)             Calculate the amount of depreciation expense per year that should be charged by GFD Ltd on the right of use asset.               

Prepare necessary journal entries in the books of GFD Ltd for the years ended 30 June 2020, 30 June 2021, 30 June 2022 and 30 June 2023 to record the lease payments.

Answer 1

PV =annual lease pmt*annuity factor=1,200,000*3.17=3,804,000

90% fair market value=4,000,000*90% =3,600,000

Transfer in substance is met, as PV is greater than 90% fair market value. So, this is a capital lease.

Under GAAP, the lower of PV or FV is recorded:

Leased equipment                                 3,804,000

       Obligations under capital lease                            3,804,000

Under IFRS, the initial direct cost is also recorded:

Leased equipment                                  3,954,000

      Obligations under finance lease                            3,804,000

      Cash                                                                                150,000

Depreciation should be over 4 years lease term as there is no ownership transfer or bargain purchase by the end of lease:

3,804,000/4=951,000

The lease payment is recorded at the end of each year:

Obligations under capital lease      1,200,000

             Cash                                                               1,200,000