On January 2016, Profit Ltd enters the contract with City Ltd for the use of a t

Question

On January 2016, Profit Ltd enters the contract with City Ltd for the use of a truck. The contract contained the following clauses:

Lease term: four years with a $6,000 purchase option at the end of the lease.

Lease payments: $200,048 per annum in advance, the first payment is made on 1 January 2016.

Fair value of the truck : $720,000

Profit Ltd incurs $50,000 initial direct cost, including $15,000 legal fees and $35,000 commission to real estate agent

At the end of the lease, Profit Ltd has express intention to exercise the purchase option.

Implicit interest rate: 8%

Estimated useful life of the truck is five years

Profit Ltd accounts for its lease using IFRS 16

(a) Determine the lease liability and initial measurement of a right-use-use asset (i.e. the truck) for Profit ltd.

(b) Prepare the lease liability movement schedule for each year for Profit Ltd.

(c) Prepare accounting journal entries for Profit Ltd for the years ended 31 December 2016 and 2017

Explanation / Answer

a) Lease liability for Profit Ltd. will be equal to sum of present value of all lease payments and present value of purchase option which is calculated as follows:-

Lease Liability = PV of Annual Lease payments+PV of Purchase Option

= [$200,048+($200,048*PVAF(3 yrs, 8%)]+[$6,000*PVF(4 yrs, 8%)]

= [$200,048+($200,048*2.5771)]+($6,000*0.735)

= $200,048+$515,544+$4,410 = $720,002

Therefore the lease liability is $720,002

Right of Use Asset will also include direct cost, legal fees and commission to real estate agent along with lease liability.

Right of use Asset = Direct Cost+Legal Fees+Commission to Real Estate Agent+Lease Liability

= $50,000+$15,000+$35,000+$720,002 = $820,002

b) Lease Liability Movement Schedule for Profit Ltd. (Amounts in $)

c) Journal Entries for Profit Ltd. (Amounts in $)

Date Opening Bal (A) Lease Payment (B) Interest Expense (C = A*8%) Decrease in Lease Liability (D = B - C) Ending Bal (A - D) 01/01/16 720,002 200,048 0 (first lease payment at the beginning) 200,048 519,954 01/01/17 519,954 200,048 41,596 158,452 361,502 01/01/18 361,502 200,048 28,920 171,128 190,374 01/01/19 190,374 200,048 15,230 184,818 5,556 01/01/20 5,556 0 444 0 6,000

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