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Financial Accounting: Theory and Practice ACCT3321

This document provides an example lease problem from an accounting textbook. It describes a lease agreement between Ottawa Ltd and Fredricton Ltd for a motor vehicle. The key details of the 3-year lease are outlined, including annual rental payments, guaranteed residual value, and extra fees. Journal entries are required to account for the lease over the term. If the guaranteed residual value was lower, the accounting entries would need to be adjusted accordingly.

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Backy Mak
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111 views

Financial Accounting: Theory and Practice ACCT3321

This document provides an example lease problem from an accounting textbook. It describes a lease agreement between Ottawa Ltd and Fredricton Ltd for a motor vehicle. The key details of the 3-year lease are outlined, including annual rental payments, guaranteed residual value, and extra fees. Journal entries are required to account for the lease over the term. If the guaranteed residual value was lower, the accounting entries would need to be adjusted accordingly.

Uploaded by

Backy Mak
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Accounting and Finance ACCT3321

Financial Accounting: Theory and Practice ACCT3321


Week 5 Leases – Lecture Problem

Picker et. al. (2006) Problem 12.4, p. 502. (note - from 2006 edition)

Ottawa Ltd decided to lease from Fredricton Ltd a motor vehicle that had a fair
value at 30 June 2007 of $38,960. The lease agreement contained the following
clauses:

Lease term (non-cancellable) 3 years


Annual rental payments (commencing 30/6/2007) $11 200
Guaranteed residual value (expected fair value at end of lease term) $12 000
Extra rental per annum if the car is used outside the metropolitan area $1 000

The expected useful life of the vehicle is five years. At the end of the three-year
lease term, the car was returned to the lessor, who sold it for $10 000. The annual
rental payments include an amount of $1 200 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 2008-09 year. The lease is considered to be a finance
lease.

Required

Part 1. Prepare the journal entries for Ottawa Ltd from 30 June 2007 to 30
June 2010

By trial and error or a financial calculator determine the interest rate of __%:

10 000 now = $__________


10 000 x 1.8594 (annuity for 2 years at __%) = $__________
12 000 x 0.86384 (PV of sum in 3 years at __%) = $__________
Total = $__________

Hint – if the interest rate is not given, use internal rate of return calculations to find
the interest rate implicit in the lease.

1
Ottawa Ltd
Lease payments schedule

MLP Interest Reduction Balance


$ $ $ $
30 June 2007 _______
30 June 2007 ______ _______ _______
30 June 2008 ______ ______ _______ _______
30 June 2009 ______ ______ _______ _______
30 June 2010 12 000 572 11 428 --
42 000 3 040 38 960

Journal entries

30 June 2007
$ $
Leased Vehicle Dr
Lease Liability Cr
(recognition of lease asset and liability)

Lease Liability Dr
Prepaid Executory Costs Dr
Cash Cr
st
(1 lease payment)

1 July 2007
$ $
Executory Costs Dr
Prepaid Executory Costs Cr
(reversal of prepayment)

30 June 2008
$ $
Lease Liability Dr
Interest Expense Dr
Prepaid Executory Costs Dr
Cash Cr
nd
(2 lease payment)

Depreciation Expense Dr
Accumulated Depreciation Expense Cr
(depreciation of the leased asset
1/3($38 960 - $12 000))

2
1 July 2008
$ $
Executory Costs Dr
Prepaid Executory Costs Cr
(reversal of prepayment)

30 June 2009
$ $
Lease Liability Dr
Interest Expense Dr
Prepaid Executory Costs Dr
Cash Cr
rd
(3 lease payment)

Contingent Rental Expense Dr


Cash Cr
(contingent rental paid)

Depreciation Expense Dr
Accumulated Depreciation Expense Cr
(depreciation of leased asset
1/3($38 960 - $12 000))

1 July 2009
$ $
Executory Costs Dr
Prepaid Executory Costs Cr
(reversal of prepayment)

30 June 2010
$ $
Depreciation Expense Dr
Accumulated Depreciation Expense Cr
(final depreciation charge
1/3($38 960 - $12 000))

Lease Liability Dr
Interest Expense Dr
Accumulated Depreciation Dr
Leased Vehicle Cr
(return of vehicle to lessor)

Loss on Guaranteed Residual Value Dr


Cash Cr
(payment required under guarantee)

3
Problem 12.4 (continued)

Part 2 – How would your answer 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?

If the guaranteed residual value were $10 000, then, although the interest rate
implicit in the lease stays at 5%, the lessee must record the leased asset and
liability at the PV of the MLP, namely $_________, calculated as follows:

$10 000 deposit ______


$10 000 x 1.8594 (PV of annuity for 2 years at 5%) ______
$10 000 x 0.86384 (PV of future sum in 3 years at 5%) ______
______

The lease schedule would then be as follows:

MLP Interest Reduction Balance


$ $ $ $
30 June 2007 37 232
30 June 2007 ______ ______ ______
30 June 2008 ______ ______ ______ ______
30 June 2009 ______ ______ ______ ______
30 June 2010 10 000 476 9 524 --
40 000 2 768 37 232

All payment journals would change to reflect the new interest expense and
reduction in liability amounts.

Depreciation expense per annum will change to 1/3($37 232 - $10 000) = $______

No payment would be required under the guarantee.

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