On January 1, 2011, Hunter Ltd. entered into an agreement to lease a truck from Situ Ltd. Both Hunter and Situ use IFRS. The details of the agreement are as follows:
Carrying value of truck for Situ Ltd.………..………………………. $20,691
Fair value of truck …………………………………………………… $20,691
Economic life of truck ………………………………………………. 5 years
Lease term …………………………………………………………… 3 years
Rental payments (at beginning of each month) …………………….. $620
Executory costs included in rental payments each month for insurance.. $20
Incremental borrowing rate for Hunter Ltd……………………………… 12%
Hunter Ltd. guarantees Situ Ltd. that at the end of the lease term Situ Ltd. will realize $3,500 from selling the truck.
Additional information:
1. There are no abnormal risks associated with the collection of lease payments from Hunter.
2. There are no additional unreimbursable costs to be incurred by Situ in connection with the leased truck.
3. At the end of the lease term, Situ sold the truck to a third party for $3,200, which was the truck’s fair value at December 31, 2010. Hunter paid Situ the difference between the guaranteed residual value of $3,500 and the proceeds obtained on the resale.
4. Hunter knows the interest rate that is implicit in the lease.
5. Hunter knows the amount of executory costs included in the minimum lease payments.
6. Hunter uses straight-line depreciation for its trucks.
Instructions
(a) Discuss the nature of this lease for both Hunter Ltd. (the lessee) and Situ Ltd. (the lessor).
(b) Assume that the effective interest of 12% had not been provided in the data. Prove the effective interest rate of 12% using a financial calculator or computer spreadsheet function.
(c) Prepare a lease amortization schedule for the full term of the lease using a computer spreadsheet.
(d) Prepare the journal entries that Hunter would make on January 1, 2011, and 2012, and any year-end adjusting journal entries at December 31, 2011, related to the lease arrangement, assuming that Hunter does not use reversing entries.
(e) Identify all accounts that will be reported by Hunter Ltd. on its comparative balance sheet at December 31, 2012, and 2011, and comparative income statement for the fiscal years ending December 31, 2012, and 2011. Include all the necessary note disclosures on the transactions related to this lease for Hunter and be specific about the classifications in each statement.
(f) Prepare the journal entry for Hunter’s payment on December 31, 2013, to Situ to settle the guaranteed residual value deficiency. Assume that no accruals for interest have been recorded as yet during 2013, but that the 2013 depreciation expense for the truck has been recorded.
(g) Prepare Hunter’s partial comparative statement of cash flows for the years ended December 31, 2012, and 2011, for all transactions related to the above information. Be specific about the classifications in the financial statement.
(a) This is a finance lease to Hunter Ltd. The IFRS criteria use qualitative factors to establish whether or not the risks and rewards of ownership are transferred to the lessee, and supports classification as a finance lease:
1. There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. If there is a bargain purchase option in the lease, it is assumed that the lessee will exercise it and obtain ownership of the asset.
2. The lease term is long enough that the lessee will receive substantially all of the economic benefits that are expected to be derived from using the leased property over its life.
3. The lease allows the lessor to recover substantially all of its investment in the leased property and to earn a return on the investment. Evidence of this is provided if the present value of the minimum lease payments is close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major modification and/or significant cost to the lessor, they are of use only to the lessee.
Other indicators include situations where the lessee absorbs the lessor’s losses if the lessee cancels the lease, or the lessee assumes the risk associated with the amount of the residual value of the asset at the end of the lease, or where there is a bargain renewal option—when the lessee can renew the lease for an additional term at significantly less than the market rent.
The standard also states that these indicators are not always conclusive. The decision has to be made on the substance of each specific transaction. If the lessee determines that the risks and benefits of ownership have not been transferred to it, the lease is classified as an operating lease.
For Situ Ltd. the lessor, under IFRS, the lease would receive the same treatment as under PE GAAP except the criteria need not include the two revenue recognition-based tests concerning collectability and estimating unreimbursable costs. Situ is not a manufacturer or dealer and so this is finance lease.
(b) Calculation of annual rental payment:
(Hint when using a financial calculator: ensure that the compounding is done monthly, P/Y = 1)
Excel formula =PMT(rate,nper,pv,fv,type) |
Using a financial calculator: | ||
PV | $ 20,691 | |
I | 1% | |
N | 36 | |
PMT | $ ? | Yields ($600) |
FV | $ (3,500) | |
Type | 1 |
The lease payments include the executory costs of $20 per month and are therefore in the amount of $620.
(c)
Lease Amortization Schedule
Date | | Monthly Lease Payment Plus GRV | | Interest (1%) on Unpaid Obligation | | Reduction of Lease Obligation | | Balance Lease Obligation | ||||||||
| | | | | | $20,691 | ||||||||||
Jan. | 1 | 2011 | $ 600 | | $600 | 20,091 | ||||||||||
Feb. | 1 | 2011 | 600 | $ 201 | 399 | 19,692 | ||||||||||
Mar. | 1 | 2011 | 600 | 197 | 403 | 19,289 | ||||||||||
Apr. | 1 | 2011 | 600 | 193 | 407 | 18,882 | ||||||||||
May | 1 | 2011 | 600 | 189 | 411 | 18,471 | ||||||||||
June | 1 | 2011 | 600 | 185 | 415 | 18,055 | ||||||||||
July | 1 | 2011 | 600 | 181 | 419 | 17,636 | ||||||||||
Aug. | 1 | 2011 | 600 | 176 | 424 | 17,212 | ||||||||||
Sep. | 1 | 2011 | 600 | 172 | 428 | 16,784 | ||||||||||
Oct. | 1 | 2011 | 600 | 168 | 432 | 16,352 | ||||||||||
Nov. | 1 | 2011 | 600 | 164 | 436 | 15,916 | ||||||||||
Dec. | 1 | 2011 | 600 | 159 | 441 | 15,475 | ||||||||||
Jan. | 1 | 2012 | 600 | 155 | 445 | 15,030 | ||||||||||
Feb. | 1 | 2012 | 600 | 150 | 450 | 14,580 | ||||||||||
Mar. | 1 | 2012 | 600 | 146 | 454 | 14,126 | ||||||||||
Apr. | 1 | 2012 | 600 | 141 | 459 | 13,667 | ||||||||||
May | 1 | 2012 | 600 | 137 | 463 | 13,204 | ||||||||||
Jun. | 1 | 2012 | 600 | 132 | 468 | 12,736 | ||||||||||
July | 1 | 2012 | 600 | 127 | 473 | 12,263 | ||||||||||
Aug. | 1 | 2012 | 600 | 123 | 477 | 11,786 | ||||||||||
Sep. | 1 | 2012 | 600 | 118 | 482 | 11,303 | ||||||||||
Oct. | 1 | 2012 | 600 | 113 | 487 | 10,816 | ||||||||||
Nov. | 1 | 2012 | 600 | 108 | 492 | 10,325 | ||||||||||
Dec. | 1 | 2012 | 600 | 103 | 497 | 9,828 | ||||||||||
Lease Amortization Schedule
Date | | Monthly Lease Payment Plus GRV | | Interest (1%) on Unpaid Obligation | | Reduction of Lease Obligation | | Balance Lease Obligation |
Jan. | 1 | 2013 | $600 | $98 | $502 | $9,326 |
Feb. | 1 | 2013 | 600 | 93 | 507 | 8,819 |
Mar. | 1 | 2013 | 600 | 88 | 512 | 8,308 |
Apr. | 1 | 2013 | 600 | 83 | 517 | 7,791 |
May | 1 | 2013 | 600 | 78 | 522 | 7,269 |
Jun. | 1 | 2013 | 600 | 73 | 527 | 6,741 |
July | 1 | 2013 | 600 | 67 | 533 | 6,209 |
Aug. | 1 | 2013 | 600 | 62 | 538 | 5,671 |
Sep. | 1 | 2013 | 600 | 57 | 543 | 5,127 |
Oct. | 1 | 2013 | 600 | 51 | 549 | 4,579 |
Nov. | 1 | 2013 | 600 | 46 | 554 | 4,025 |
Dec. | 1 | 2013 | 600 | 40 | 560 | 3,465 |
Dec. | 31 | 2013 | 3,500 | 36* | 3,464 | 0 |
| | | $25,100 | $4,409 | $ 20,691 | |
* Rounding $1
(d)
January 1, 2011
Leased Equipment...................... 20,691
Lease Obligation.................. 20,691
(To record the lease of equipment
using capital lease method)
Lease Obligation...................... 600
Insurance Expense..................... 20
Cash.............................. 620
(To record the first rental payment)
December 31, 2011
Interest Expense...................... 155
Interest Payable.................. 155
(To record accrual of Dec/2011 interest on
lease obligation)
Depreciation Expense.................. 5,730
Accumulated Depreciation—Leased
Assets.......................... 5,730
(To record depreciation expense for
first year [$20,691 - $3,500] ÷ 3)
January 1, 2012
Lease Obligation...................... 445
Interest Payable...................... 155
Insurance Expense..................... 20
Cash.............................. 620
(e)
Hunter Ltd.
Statement of Financial Position
December 31,
2012 2011
Non-current assets
Property plant and equipment
Leased Equipment $20,691 $20,691
Less accumulated depreciation 11,460 5,730
9,231 14,961
Current liabilities
Interest payable 98 155
Lease obligation* 9,828 5,704
Non-current liabilities
Lease obligation (Note X) 15,475
Current portion (5,704)
(Note X)
The following is a schedule of future minimum payments under finance lease expiring December 31, 2013, together with the present balance of the obligation under the lease.
2012 2011
Amounts due in 2012 $7,440
Amounts due in 2013 $10,940 10,940
10,940 18,380
Amount representing executory costs (240) (480)
Amount representing interest (774) (2,270)
Balance of obligation $9,926 $15,630
From lease amortization schedule:
Balance at December 31 $9,828 $15,475
Add accrued interest 98 155
Balance $9,926 $15,630
Hunter Ltd. | |
Income Statement | |
For the Year Ended December 31, | |
| |
2012 2011 |
Administrative expense
Depreciation expense $5,730 $5,730
Insurance expense 240 240
Other expenses
Interest expense* 1,497 2,139
* from lease amortization schedule part (c)
(f)
December 21, 2013
Interest Expense...................... 36
Lease Obligation...................... 3,465*
Accumulated Depreciation—Leased
Assets.......................... 17,190
Loss on Capital Leases................ 300
Leased Equipment.................. 20,691
Cash.............................. 300
* rounding $1
(g)
Hunter Ltd. | |
Statement of Cash Flows | |
For the Year Ended December 31, | |
| |
2012 2011 |
Indirect Format:
Cash flows from operating activities
Depreciation expense $5,730 $5,730
Increase (decrease) in interest payable (57)* 155
Financing Activities:
Lease payment ** (5,646) (5,216)
* ($155 – $98)
** from lease amortization schedule part (c)
In the notes to the financial statements:
Non-cash Investing and Financing Activities:
Purchase of truck with lease $20,691
Direct Format:
Cash flows from operating activities
Cash paid for interest ($1,554) ($1,984)
Cash paid for insurance (240) (240)
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