On January 1, 2015, Alpha Corp. entered into a noncancelable lease for a machine

ID: 2423407 • Letter: O

Question

On January 1, 2015, Alpha Corp. entered into a noncancelable lease for a machine to be used by Evans Company in its manufacturing operations. The lease transfers ownership of the machine to the Evans Company by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2015, was one of eight equal annual payments. The CEO of Evans has asked you, the Controller, to treat the lease as an operating lease for reporting purposes.

Required: 1. How would you respond to your CEO's request? 2. Describe the expenses related to this lease that Evans will incur during the first year of the lease, and how will they be determined. 3. How should the lease be reported on Evan's December 31, 2015, balance sheet?

Explanation / Answer

As per AASB 117, the lease can be classified as finance lease or operating lease depending on the risks and rewards of the ownership which may either be retained by lessor or can be transferred to lessee.

Conditions for satisfying the lease to be classified as a finance lease are as follows:

In the present case, all the above conditions are satisfied and hence the lease is to be classified as a finance lease.

For annual depreciation of asset

Depreciation

To Accumulated depreciation

For payment of lease rentals

Interest expense

Lease liability

To cash

the lease should be reported as follows:

the machine should be reported as fixed asset.

the payments due towards lease should be reported as long term liability.