SS Exercises fe MODERATE sex DIFFICULT ener EE IDENTIFICATION OF LEASES F eaeencucuring arangements, discuss whether they are in substance’ lease tansactions, and thus fll under the ambit of IAS 17, (©) Eris leases an asset Entity B, and obtains a non-recourse loan from a financial institution using the lease rentals and asset as collateral, Eniy A ell the astet subject the lease and the lear ae {ustee, and leases the same asset back. (©) Entity enters into an arrangement to buy petroleum products from Entity B, The products Encly B coald pretty built and operated by Entity B on a site owned by Entiy Av Although FeaityB cold Provide the product from other refineries which it owns, itis not practical es dee” can, Brciains the right to sell products produced by the refinery to other customers but there only a remote possibility that it will do s0. The arrangement requires Entity A to make unavoidable payments and variable payments based on inp Entity B (6) fg A leases an asset to Entity B for its emtie economic life and leases the same asset back under {be same terms and conditions as the original lease. The two entities have a legally colerecaige right tosis, OF HE amounts owing to one another, and an intention to sell these amounis era one basis. (o) Fay enters into a non-cancellable 4-year lease wth Entity B for an asset with an expected economic Uf of 20 years. Entity A has an option to renew the lease fora further & yeast theced of aoe sree conclusion of the lease arangement, che asset will revert back to Entity & Ina tense Saari ety Sis granted a put option to sell the asset to Entity A should its market value oe che end of the lease be less than the residual value ee ins 2 successful chain of fashion boutiques, but has been experiencing significant cash flow Problems. The directors are examining a proposal made by an accounting consullent ake ah e shops feaeed shea by the company be sold and either leased back or the businesses moved to aerate tessed shops. The directors are Keen on the plan but are puzzled by the conaulants nvieeeee he aa agreements for the shops be ‘operating’ rather than ‘finance’ leaseg oth fixed put costs at a target level of efficiency to Required 1. Explain the difference between a finance lease and an operating leas 2 fablain. by reference tothe requirements of AS 17, why the consultant prefers operating to finance leases 3. Describe three disadvantages to the company of entering into finance le ep akakane ais fou mulplechoice questions. Select the comect answer and show any workings equine * Pukghohe Lad sells land that originally cost $150000 to Taupo Lid for $230000 when fhe 1a fair Yalue is $215 000, and then enters into a cancellable lease agreement to use the land for 3 years at an Xe Be Jena! of $2000. In the current year, how much profit would Pukekohe Lid record on ihe mast -ase agreements, the land? (a) $15000 (b) $80000 (0) $65 000 (a) Nil 2. Using the information from part 1 above, how would Taupo Lid record the Pukekohe Lid? (a) As rental revenue (b) As a reduction of the lease receivable (0) As rental expense (4)As interest revenue and a reduction of the lease receivable annual cash received from 452 PART2 Elements3. On 1 July 2014, Masterton Ltd leases a machine with a fair value of $109 445 10 Tokoroa Ltd for 5 years fat an annual rental (in advance) of $25000, and Tokoroa Ltd guarantees in full the estimated residual ‘value of $15 000 on return of the asset. What would be the interest rate implicit in the Tease? (a) 10% (9 9% (b) 12% (@) 149% 4, Using the information from part 3, how would Tokoroa Ltd classify the lease? (a) As an operating lease (b) Asa finance lease (c) Asa sale and leaseback (@) Asa lease incentive LEASE INCENTIVES, As an incentive to enter a non-cancellable operating lease for office premises for 10 years, the lessor has offered the lessee a rent-free period of 2 years. Rental payments under the lease beginning in year 3 are $5000 pa. Required Prepare journal entries to account for the lease payment in year 3 of the lease in the records of both the lessor and the lessee FINANCE LEASE If a lease has been capitalised as a finance lease, identify two circumstances in which the lease receivable raised by the lessor will differ from the lease asset raised by the less poe * FINANCE LEASE — LESSOR (On 1 July 2013, Jane Plum decided she needed a new car. She went to the local car yard, North Ltd, run by Fred Peach. Jane discussed the price of a new Roadster Special with Fred, and they agreed on a price of $3700. As North Ltd had acquired the vehicle from the manufacturer for $30 000, Fred was pleased ‘with the deal. On learning that Jane wanted to lease the vehicle, Fred agreed to arrange for South Ltd, 4 local finance company, to set up the lease agreement. North Ltd then sold the car to South Ltd for $37 000, ‘South Lid wrote a lease agreement, incurring initial direct costs of $1410 as a result. The lease agreement contained the following provisions: Initial payment on 1 July 2013, $13.000 Payments on 1 July 2014 and 1 July 2015 313.000 Guaranteed residual value at 30 June 2016 10000 Implicit interest rate in the lease 6% The lease is non-cancellable. South Ltd agreed to pay for the insurance and maintenance of the vehicle, the latter to be carried out by North Ltd at regular intervals. The cost of these services is valued at $3000 p.a. The vehicle had an expected useful life of 4 years. The expected residual value of the vehicle at 30 June 2016 was $12000, Costs of maintenance and insurance incurred by South Ltd over the years ended 30 June 2014 to 30 June 2016 were $2810, $3020 and $2750 respectively. At 30 June 2016, Jane returned the vehicle to South Lid, which sold the car for $9000 on 5 July 2016 and invoiced Jane for the appropriate balance. Jane subse quently paid the debt on 13 July 2016. Required 1. Assuming the lease is classified as a finance lease, prepare in relation to the lease from 1 July 2013 to 31 July 2016, 2. In relation to finance leases, explain why the balance of the asset account raised by the lessee at the inception of the lease may differ from the balance of the receivable asset raised by the lessor. e journal entries in the books of South Ltd CHAPTER 12 Leases 453, etlBEd LEASE CLASSIFICATION; ACCOUNTING BY LESSEE % On 1 July 2013, Otago Ltd leased a plastic-moulding machine from Nelson Ltd. The machine cost Nelson '$1300000 to manufacture and had a fair value of $154 109 on 1 July 2013. The lease agreement contained. the following provisions: Lease term 4 years Annual rental payment, in advance on 1 July each year $41500 Residual value at end of the lease term 150000 Residual guaranteed by lessee nil Interest rate implicit in lease 8% ‘The lease is cancellable only with the permission of the lessor. The expected useful life of the machine is 6 years. Otago Ltd intends to return the machine to the lessor at the end of the lease term. Included in the annual rental payment is an amount of $1500 to cover the costs of maintenance and insurance paid for by the lessor. Required 1, Classify the lease for both lessee and lessor based on the guidance provided in IAS 17, justify your Prepare (a) the lease schedules for the lessee (show all workings), and (b) the journal entries in the books of the lessee for the year ended 30 June 2014, LEASE CLASSIFICATION; ACCOUNTING BY LESSOR % Use the information contained in exercise 12.7 to complete the following: 1. Classify the lease for both lessee and lessor based on the guidance provided in IAS 17. Justify your 2. Prepare (a) the lease schedules for the lessor (show all workings) and (b) the journal entries in the books of the lessor for the year ended 30 June 2014, ACCOUNTING BY LESSEE AND LESSOR (On 1 July 2014, Christchurch Ltd leased a processing plant to Wellington Ltd. The plant was purchased by Christchurch Ltd on 1 July 2014 for its fair value of $467 112. The lease agreement contained the following, provisions: Lease term 3 years Economic life of plant 5 years Annual rental payment, in arrears (commencing 30/6/2015) $150000 Residual value at end of the lease term 90.000 Residual guaranteed by lessee 60000 Interest rate implicit in lease 7% The lease is cancellable only with the permission of the lessor. ‘Wellington Ltd intends to return the processing plant to the lessor at the end of the lease term. The lease has been classified as a finance lease by both the lessee and the lessor Required 1. Prepare (a) the lease payment schedule for the lessee (show all workings) (b) the journal entries in the records of the lessee for the year ended 30 June 2016. 2. Prepare: (a) the lease receipt schedule for the lessor (show all workings) (b) the journal entries in the records of the lessor for the year ended 30 June 2016. 454° PART2 Elements| | Hamilton Ltd prepares the following lease payments schedule for the lease of a machine from Hutt Ltd. The machine has an economic life of 6 years. The lease agreement requires four annual payments of $3000, and the machine will be returned to Hutt Led at the end of the lease term. The lease payments schedule is Interest Reduction in Balance of MLP expense (10%) Hability liability 1 July 2012 s985i2 | 1 July 2013 $ 30000 § 9851 $20149 78363 1 July 2014 30000 7836 22164 56199 1 July 2015 30000 5620 24380 31819 | 1 July 2016 35000 3181 31819 . $125000 26488, 98512 The following five multp show any workings required 1. In its notes to the accounts at 30 June 2014, Hamilton Ltd would disclose future lease payments of what amount? (a) $95000 (c) $9900 (b) $6500 (4) $104000 2. For the year ended 30 June 2013, what would Hamilton Ltd record in relation to the lease? (a) An interest payable of $26 488 (b) An interest payable of $nil (c) An interest payable of $9851 (d) An interest payable of $7836 3. How much annual depreciation expense would Hamilton Ld record? (a) $24628 (b)si6419 (o) 15585 («) 823378 4. If Hutt Ltd (the lessor) records a lease receivable of $102 327, the variance between this receivable and the liability of $98 512 recorded by Hamilton Ltd could be dive to what? (a) Initial direct costs paid by Hutt Ltd (b) An unguaranteed residual value (c) Both of the above (d) Neither of the above ‘Assume that the 1 July 2013 lease payment included an additional amount of $3000 for exceeding a limit for machine usage hours specified in the lease agreement. Hamilton Ltd would account for this charge by recognising it as what? (a) An expense and disclosing the amount in the notes (if material) (b) Additional executory costs () Revenue (d)A reduction in the lease liability rice questions relate to the infor nation provided above Select the correct answer and x LEASE CLASSIFICATION New Ltd manufactures specialised moulding machinery for both sale and lease, On 1 July 2014, New Lid leased a machine to Zealand Lid. The machine being leased cost New Ltd $195.00 to make and its fair value at 1 July 2014 is considered to be $212515, The terms of the lease are as follows: The lease term is for 5 yeats, starting on ‘Aninual lease payment, payable on 30 June each year Estimated useful life of machine (scrap value $2500) 8 years Estimated residual value of machine at end of lease term $3700 (continued) CHAPTER 12 Leases 485EE Residual value guaranteed by Zealand Ltd $25.00 Interest rate implicit in the lease 10% The annual lease payment includes an amount of $7500 to cover annual maintenance and insurance costs Zealand Ltd may cancel the lease but only with the permission ofthe lessor. Zealand Ltd intends o lease a new machine atthe end of the lease term, Required Classify the lease for both New Ltd and Zealand Ltd. Justify your answer. LEASE SCHEDULES AND JOURNAL ENTRIES (YEAR 1) On 1 July 2014, Island Ltd leased a crane from Pacific Ltd. The crane cost Pacific Ltd $120 307, considered to be its fair value on that same day. The finance lease agreement contained the following provisions: ‘The lease term is for 3 years, stating on 1 July 2014 The lease is non-cancellable ‘Annual lease payment, payable on 30 June each year 39.000 Estimated useful life of crane 4 years Estimated residual value of crane at end of lease term $22.00 Residual value guaranteed by Island Lid $16000 Interest rate implicit inthe lease 7% The lease was classified as a finance lease by both Island Ltd and Pacific Lid at 1 July 2014. Required 1. Prepare the lease schedules for both the lessee and the lessor. 2. Prepare the journal entries in the records of the lessee only for the year ended 30 June 2015. FINANCE LEASE — LESSEE (INCLUDING DISCLOSURES) Dunedin Ltd decided to lease from Rotorua Ltd a motor vehicle that had a fair value at 30 June 2012 of $38,960, The lease agreement contained the following provisions: Lease term (non-cancellable} 3 years ‘Annual rental payments (commencing 30/6/12) 1200 Guaranteed residual value (expected fair value at end of lease term) $12000 Extra rental per annum if the car is used outside the metropolitan area $1000 The expected useful life of the vehicle is 5 years. At the end of the 3-year lease term, the car was returned to the lessor, which sold it for $10.000. The annual rental payments include an amount of $1200 to cover the cost of maintenance and insurance arranged and paid for by the lessor. The car was used outside the ‘metropolitan area in the 2013-14 year. The lease is considered to be a finance lease Required 1, Prepate the journal entries for Dunedin Lid from 30 June 2012 to 30 June 2015. 2. Prepare the relevant disclosures required under IAS 17 for the years ending 30 June 2013 and 30 June 2014. 3, How would your answer to requirement 1 change if the guaranteed residual value was only $10 000, and the expected fair value at the end of the lease term was $12 000? SALES AND LEASEBACK #_ Ultramarine Ltd is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it entered into an agreement on 1 July 2013 to sell its processing plant 1o Wanganui Ltd for $467 100. At the date of sale 456 PART? Elementsthe plant had a carrying amount of $400 000 and a future useful life of S years. Wanganui Ltd immediately leased the processing plant back to Ultramarine Ltd, The terms of the lease agreement were Lease term 3 years Economic life of plant 5 years Annual rental payment, in arrears (commencing 30/6/14) $165.00 Residual value of plant at end of lease term $90. 000 Residual value guaranteed by Ultramarine Lid 60.000 Interest rate implicit in the lease 6% The lease is cancellable, but only with the permission ofthe lessor At the end of the lease term, the plant is to be returned to Wanganui Ltd, In setting up the lease agree- ‘ment Wanganui Ltd incurred $9414 in legal fees and stamp duty costs. The annual rental payment includes $15 000 to reimburse the lessor for maintenance costs incurred on behalf of the lessee Req 1, Classify the lease for both lessor and lessee. Justify your answer Prepare a lease payments schedule and the journal entries in the records of Ultramarine Ltd for the year ending 30 June 2014. Show all workings. Prepare a lease receipts schedule and the journal entries in the records of Wanganui Ltd for the year ending 30 June 2014. Show all workings. 4. Explain how and why your answers to requirements 1 and 2 would change ifthe lease agree: be cancelled at any time without penalty. Explain how and why your answer to requirements 1, 2 and 3 would change if the processing plant had been manufactured by Wanganui Lid at a cost of $400.000, nt could ee SALE AND LEASEBACK ARRANGEMENTS Kapiti Ltd is a company involved in a diverse range of activities involving power generation, machinery retailing and agriculture. The accounting policy note attached to the 2010 fina following under the heading ‘Leases ncial statements included the During the year the company entered into a refinancing arrangement which involved the sale of the Lilac Moun tain power station under a sale and leaseback arrangement. The difference between the carrying amount ofthe power station and its original cost has been ineluded in profit and disclosed asa gain on sale of a non-current asst. Sales proceeds in excess of the original cast have been teated as deferred income in the statement of finan {al position, The amount of deferred income will be systematically amorised over the term of the lease The power station is a unique asset in that the licence to generate power from that station is held by Kapiti Lid and cannot be transferred. The leaseback period is for the remaining 20 years economic life of the power station and Kapiti Lid has guaranteed its expected residual value at that time of $55 000. Required 1. Does the Kapiti Led s your choice le and leaseback arrangement involve a finance lease or an operating lease? Justify 2. Critically evaluate the accounting treatment adopted by Kapiti Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of IAS 17 3. Compare the resulting deferred income account with the Conceptual Frame ork’s definitions of and ognition criteria for the elements of financial statements. LEASE CLASSIFICATION; ACCOUNTING AND DISCLOSURES Birkenhead Ltd has entered into an agreement to lease a D9 bulldozer to Albert Ltd. The lease agreement details are as follows: Length of lease a Commencement date 1 July 2013 ‘Annual lease payment, payable 30 June each year commencing 30 June 2014 $6 Fair value of the bulldozer at 1 July 2013 $34797 continued) CHAPTER 12 Leases 457Estimated economic life of the bulldozer B years Estimated residual value of the plant atthe end ofits economic life $2000 Residual value atthe end of the lease term, of which 50% is guaranteed by Albert Lid $7200 Interest rate implicit in the lease The lease is cancellable, but a penalty equal to 50% of the total lease payments is payable on cancella tion. Albert Ltd does not intend to buy the bulldozer at the end of the lease term. Birkenhead Ltd incurred $1000 to negotiate and execute the lease agreement, Birkenhead Lid purchased the bulldozer for $34 797 just before the inception of the lease. Required 1. State how both companies should classify the lease. Give reasons for your answer. 2. Prepare a schedule of lease payments for Albert Lid 3, Prepare a schedule of lease receipts for Birkenhead Ltd 4. Prepare journal entries to record the lease transactions for the year ended 30 June 2014 in the records of both companies. 5, Prepare an appropriate note to the fin ncial statements of both companies as at 30 June 2014 xx On 1 July 2013, Porirua Led acquired an item of plant for $31 864. On the same date, Porirua Ltd entered into lease agreement with Hastings Ltd in relation to the asset, According to the lease agreement, Hastings Ld ‘agreed to pay $12 000 immediately, witha further two payments of $12 000 on 1 July 2014 and 1 July 2015. ‘At 30 June 2016, the asset is to be returned to the lessor and its residual value is expected to be $6000. Hastings Ltd has agreed to guarantee the expected residual value at 30 June 2013. All insurance and main: tenance costs are to be paid by Porirua Ltd and are expected to amount to $2000 p.a. The costs of pre paring the lease agreement amounted 10 $360. The interest rate implicit in the lease is 996. The lease is classified as a finance lease, Plant is depreciable on a straight-line basis. Required 1. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 2. Prepare a schedule of lease payments for Hastings Ltd and the journal entries for the year ended 30 june 2014. 3, Assume that Hastings Ltd guaranteed a residual value of only $4000. Prepar Porirua Ltd and Hastings Lid. 4. Instead of acquiring the plant for $31 864, assume that Porirua Ltd manufactured the plant at a cost of 529 500 before entering into the lease agreement with Hastings Lid. Prepare a schedule of lease receipts for Porirua Ltd and the journal entries for the year ended 30 June 2014. 5. Assume that Hastings Lid manufactured the plant itself at a cost of $29500 and sold the plant to Porirua Lad for $31 864. Hastings Ltd then leased it back under the original terms of the finance lease with Hastings Lid guaranteeing a residual value of $4000. Prepare a lease schedule and journal entries for both Porirua Lid and Hastings Ltd for the year ended 30 June 2014. e a lease schedule for both Ete FINANCE LEASE — MANUFACTURER LESSOR ‘xx Auckland Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July 2013, ‘Auckland Ltd leased a machine to Christchurch Ltd, incurring $1500 in costs to prepare and execute the Tease document. The machine being leased cost Auckland Ltd $195 000 to make and its fair value at 1 July 2013 is considered to be $212515. The terms of the lease agreement are as follows: Lease term commencing on 1 July 2013 5 years Annual lease payment commencing on 1 July 2014 $57 500 Estimated useful life of machine (crap value $2500) B years Estimated residual value of machine at end of lease term $3700 Residual value guaranteed by Christchurch Ltd $25000 Interest rate implicit in the lease 10% The lease is classified as a finance lease 458. PART2 Flementsila red 797 sof m= | 2ou4. O June both y 2013, cute the The annual lease payment includes an amount of 500 to cover annual maintenance and insurance costs. Actual executory costs for each of the 5 years were: 2013-14 $7200 2014-15, 7700 2015-16 00 2016-17 7100 2017-18 7000 Christchurch Lid may cancel the lease but will incur a penalty equivalent to 2 years payments if it does so, Christchurch Ltd intends to lease a new machine at the end of the lease term, The end of the reporting, period for both companies is 30 June Required 1. Prepare a schedule of lease receipts for Auckland Ltd 2. Prepare the general journal entries to record the lease transactions for the year ended 30 June 2014 in the records of Auckland Ltd. cor: FINANCE LEASE — LESSEE AND LESSOR On 1 July 2014, Wellington Lid acquired a new car. The manager of Wellington Ltd, Jack Wellington, went to the local car yard, Hamilton Autos, and discussed the price of a new Racer Special with John Hamilton Jack and John agreed on a price of $37 876. As Hamilton Autos had acquired the vehicle from the manufac turer for $32,000, John was pleased with the deal. On discussing the financial arrangements in relation to the car, Jack decided that a lease arrangement was the most suitable. John agreed to arrange for Dunedin Ltd, a local finance company, to set up the lease agreement. Hamilton Autos then sold the car to Dunedin Lid for $37 876, Dunedin Ltd wrote a lease agreement, incurring initial direct costs of $534 in the process, The lease agreement contained the following clauses: Initial payment on 1 July 2014 $13.000 Payments on 1 July 2015 and 1 July 2016 513.000 Interest rate implicit in the lease 6% The lease agreement also specified for Dunedin Ltd to pay for the insurance and maintenance of the vehicle, the latter to be cartied out by Hamilton Autos at regular intervals, A cost of $3000 per annum was included in the lease payments to cover these serv Jack wanted the lease to be considered an operating lease for accounting purposes. To achieve this, the Tease agreement was worded as follows: * The lease is cancellable by Wellington Ltd at any stage. However, if the lease is cancelled, Wellington Lid agrees to lease, on similar terms, another car from Dunedin Lid, ‘+ Wellington Lad is not required to guarantee the payment of any residu term, 30 June 2017, or if cancelled eatlier, the car automatically rex being required from Wellington Led. The vehicle had an expected economic life of 6 years. The expected fair value of the vehicle at 30 June 2017 was $12,000. Because of concer over the residual value, Dunedin Ltd required Jack to sign another contractual arrangement separate from the lease agreement which gave Dunedin Ltd the right to sell the cat to Wellington Ltd if the fair value of the car at the end of the lease term was less than $10 000, Costs of maintenance and insurance paid by Dunedin Ltd to Hamilton Autos over the years ended 30 June 2015 to 30 June 2017 were $2810, $3020 and $2750, AL30 June 2017, Jack returned the vehicle to Dunedin Lid. The fair value of the car was determined by to be $9000. Dunedin Lid invoked the second agreement. With the consent of Wellington, Dunedin Ltd sold the car to Hamilton Autos for a price of $9000 on 5 July 2017, and invoiced ‘Wellington Lid subsequently paid this amount on 13 July 2% ial value. At the end of the lease sto the lessor with no payments ington Ltd for $1000, CHAPTER 12 Leases 459