Week 8 Tutorial Solutions

Question 10.7 Accounting for a finance lease by the lessee and lessor

On 1 July 2015, Lions Den Ltd leased a plastic-moulding machine from Jersey City Ltd. The
machine cost Jersey City Ltd $130 000 to manufacture and had a fair value of $154 109 on 1
July 2015. The lease agreement contained the following provisions:

Lease term 4 years

Annual rental payment, in advance on 1 July each year $41 500
Residual value at end of the lease term $15 000
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. Lions Den 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
B. Prepare (1) the lease payment schedule for the lessee (show all workings); and (2) the
journal entries in the accounting records of the lessee for all years of the lease.
C. Prepare (1) the lease receipt schedule for the lessor (show all workings); and (2) the
journal entries in the accounting records of the lessor for all years of the lease.

PART B – ACCOUNTING BY LESSEE

(1) Lease payment schedule

Lions Den Ltd (Lessee)

Schedule of lease payments\

MLP Interest Liability Liability

expense reduction balance

$ $ $ $

1 July 2015 143 084

1 July 2015 40 000 - 40 000 103 084

1 July 2016 40 000 8 247 31 753 71 331

1 July 2017 40 000 5 706 34 294 37 037

1 July 2018 40 000 2 963 37 037 -

160 000 16 916 143 084

(2). Journal entries

Lions Den Ltd (Lessee)

1 July 2015

Leased Machine Dr 143 084

Lease Liability Cr 143 084

(Inception of lease)

Lease Liability Dr 40 000

Prepaid Ins & Maintenance Dr 1 500

Cash Cr 41 500

(First lease payment in advance)

30 June 2016

Ins & Maintenance Expense Dr 1 500

Prepaid Ins & Maintenance Cr 1 500

(Adjusting entry for prepayment)

Interest Expense Dr 8 247

Interest Payable Cr 8 247

(Interest accrued at year end)

Depreciation Expense Dr 35 771

Accumulated Depreciation Cr 35 771

(Depreciation for year 1, $143 084 ÷ 4)

1 July 2016

Lease Liability Dr 31 753

Interest Payable Dr 8 247

Prepaid Ins & Maintenance Dr 1 500

Cash Cr 41 500

(Second lease payment in advance)

30 June 2017

Ins & Maintenance Expense Dr 1 500

Prepaid Ins & Maintenance Cr 1 500

(Adjusting entry for prepayment)

Interest Expense Dr 5 706

Interest Payable Cr 5 706

(Interest accrued at year end)

Depreciation Expense Dr 35 771

Accumulated Depreciation Cr 35 771

(Depreciation for year 2, $143 084 ÷ 4)

1 July 2017

Lease Liability Dr 34 294

Interest Payable Dr 5 706

Prepaid Ins & Maintenance Dr 1 500

Cash Cr 41 500

(Third lease payment in advance)

30 June 2018

Ins & Maintenance Expense Dr 1 500

Prepaid Ins & Maintenance Cr 1 500

(Adjusting entry for prepayment)

Interest Expense Dr 2 963

Interest Payable Cr 2 963

(Interest accrued at year end)

Depreciation Expense Dr 35 771

Accumulated Depreciation Cr 35 771

(Depreciation for year 3, $143 084 ÷ 4)

1 July 2018

Lease Liability Dr 37 037

Interest Payable Dr 2 963

Prepaid Ins & Maintenance Dr 1 500

Cash Cr 41 500

(Fourth lease payment in advance)

30 June 2019

Ins & Maintenance Expense Dr 1 500

Prepaid Ins & Maintenance Cr 1 500

(Adjusting entry for prepayment)

Depreciation Expense Dr 35 771

Accumulated Depreciation Cr 35 771

(Depreciation for year 4, $143 084 ÷ 4)

Accumulated Depreciation Dr 143 084

Leased Machine Cr 143 084

(De-recognition of lease asset)

PART C – ACCOUNTING BY LESSOR

Jersey City Ltd is a manufacturer/dealer lessor. The significance of this classification is that:
• there is a selling profit to Jersey City Ltd on entering into the lease arrangement
• initial indirect costs are not included the initial recognition of the lease receivable but treated
as part of the sale transaction

The lease receivable is initially measured at the fair value of $154 109 calculated as follows:

Net investment in lease = PV of MLP + PV of Unguaranteed Residual Value (UGRV)

PV of MLP = 40 000 + 40 000 x 2.5771 [T2 8% 3 yrs]

= 40 000 + 103 084

=143 084

PV of UGRV = 15 000 x 0.7350 [T1 8% 4 yrs]

= 11 025
Net investment in lease = 143 084 + 11 025 = $154 109

(1) Lease receipts schedule

Jersey City Ltd (Lessor)

Lease receipts schedule

MLR Interest Receivable Receivable

revenue reduction balance

$ $ $ $

1 July 2015 154 109

1 July 2015 40 000 - 40 000 114 109

1 July 2016 40 000 9 129 30 871 83 238

1 July 2017 40 000 6 659 33 341 49 897

1 July 2018 40 000 3 992 36 008 13 889

30 June 2019 15 000 1 111 13 889 -

175 000 20 891 154 109

(1) Journal Entries

Jersey City Ltd (Lessor)

1 July 2015

Lease Receivable Dr 154 109

Inventory Cr 130 000

Cost of Sales Dr *118 975

Sales Revenue Cr **143 084

(Inception of lease)

(* Cost less PV of UGRV [15 000 x 0.735])

(** PV of MLP)

Cash Dr 41 500

Unearned Revenue Cr 1 500

Lease receivable Cr 40 000

(First lease receipt in advance)

30 June 2016

Unearned Revenue Dr 1 500

Reimbursement Revenue Cr 1 500

(Adjusting entry for unearned revenue)

Interest Receivable Dr 9 129

Interest Revenue Cr 9 129

(Interest revenue accrued at year end)

1 July 2016

Cash Dr 41 500

Interest Receivable Cr 9 129

Unearned Revenue Cr 1 500

Lease receivable Cr 30 871

(Second lease receipt in advance)

30 June 2017
Unearned Revenue Dr 1 500

Reimbursement Revenue Cr 1 500

(Adjusting entry for unearned revenue)

Interest Receivable Dr 6 659

Interest Revenue Cr 6 659

(Interest revenue accrued at year end)

1 July 2017

Cash Dr 41 500

Interest Receivable Cr 6 659

Unearned Revenue Cr 1 500

Lease receivable Cr 33 341

(Third lease receipt in advance)

30 June 2018

Unearned Revenue Dr 1 500

Reimbursement Revenue Cr 1 500

(Adjusting entry for unearned revenue)

Interest Receivable Dr 3 992

Interest Revenue Cr 3 992

(Interest revenue accrued at year end)

1 July 2018

Cash Dr 41 500

Interest Receivable Cr 3 992

Unearned Revenue Cr 1 500

Lease receivable Cr 36 008

(Fourth lease receipt in advance)

30 June 2019

Unearned Revenue Dr 1 500

Reimbursement Revenue Cr 1 500

(Adjusting entry for unearned revenue)

Inventory Dr 15 000

Interest Revenue Cr 1 111

Lease Receivable Cr 13 889

(Return of equipment at lease end)

The lessor would also record insurance and maintenance expenses during the lease term for the
insurance and maintenance costs it incurs in relation to the plastic moulding machine.
Question 10.11 Accounting for a sale and leaseback transaction by the
lessee and lessor
Squeal Ltd is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it
entered into an agreement on 1 July 2015 to sell its processing plant to Tyres Ltd for
$467 100. At the date of sale, the plant had a carrying amount of $400 000 and a future useful
life of 5 years. Tyres Ltd immediately leased the processing plant back to Squeal Ltd. The
terms of the lease agreement were:

Lease term 3 years

Economic life of plant 5 years
Annual rental payment, in arrears (commencing $165 000
30/6/16)
Residual value of plant at end of lease term $90 000
Residual value guaranteed by Squeal Ltd $60 000
Interest rate implicit in the lease 6%
The lease is cancellable, but only with the permission
of the lessor.

At the end of the lease term, the plant is to be returned to Tyres Ltd. In setting up the lease
agreement Tyres 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.

Required
B. Prepare a lease payments schedule and the journal entries in the records of Squeal Ltd
for the lease. Show all workings.
C. Prepare a lease receipts schedule and the journal entries in the records of Tyres Ltd
for the lease. Show all workings.
E. Explain how and why your answer to requirements A, B and C would change if the
processing plant had been manufactured by Tyres Ltd at a cost of $400 000.

PART B – LEASE PAYMENTS SCHEDULE AND JOURNALS

1. Lease repayment schedule

Squeal Ltd (Lessee)

Lease Payments Schedule

Date MLP Interest Reduction of Balance of lease

liability liability
Expense

$ $ $ $

1 July 2015 451 326

30 June 2016 150 000 27 080 122 920 328 406

30 June 2017 150 000 19 704 130 296 198 110

30 June 2018 150 000 11 890 138 110 60 000

30 June 2018 60 000 - 60 000

510 000 58 674 451 326 -

2. Accounting for the lease in the books of Squeal Ltd (lessee)

Journal Entries

1 July 2015

Cash Dr 467 100

Deferred gain on sale Cr 67 100

Processing plant Cr 400 000

(Sale of plant under sale

and leaseback agreement)

Leased plant Dr 451 326

Lease liability Cr 451 326

(Recognition of lease agreement)

30 June 2016

Lease liability Dr 122 920

Interest expense Dr 27 080

Executory costs expense Dr 15 000

Cash Cr 165 000

(First lease payment in arrears)

Depreciation expense Dr 130 442

Accumulated depreciation Cr 130 442

(Depreciation of leased asset

[($451 326 – 60 000)/3]

Deferred gain on sale Dr 22 367

Revenue on sale Cr 22 367

(Amortisation of deferred gain - $67 100/3)

30 June 2017

Lease liability Dr 130 296

Interest expense Dr 19 704

Executory costs expense Dr 15 000

Cash Cr 165 000

(Second lease payment in arrears)

Depreciation expense Dr 130 442

Accumulated depreciation Cr 130 442

(Depreciation of leased asset

[($451 326 – 60 000)/3]

Deferred gain on sale Dr 22 367

Revenue on sale Cr 22 367

(Amortisation of deferred gain - $67 100/3)

30 June 2018

Lease liability Dr 138 110

Interest expense Dr 11 890

Executory costs expense Dr 15 000

Cash Cr 165 000

(Third lease payment in arrears)

Depreciation expense Dr 130 442

Accumulated depreciation Cr 130 442

(Depreciation of leased asset

[($451 326 – 60 000)/3]

Deferred gain on sale Dr 22 367

Revenue on sale Cr 22 367

(Amortisation of deferred gain - $67 100/3)

Lease liability Dr 60 000

Leased plant Cr 60 000

(Return of leased asset to lessor)

Leased plant Dr 391 326

Accumulated depreciation Cr 391 326

(De-recognition of leased asset)

PART C – LEASE RECEIPTS SCHEDULE AND JOURNALS

Lessor is a financier lessor (i.e. non-maufacturer/non-dealer) therefore:

Net investment in the lease = fair value of leased asset + initial indirect costs

= 467 100 + 9 414 = $476 514

Net investment in the lease = PV of MLP + PV of UGRV

= 451 326 + 30 000 x 0.8396 [T1 6% 3 years]

= $476 514

1. Lease receipts schedule

Tyres Ltd (Lessor)

Lease Receipts Schedule

Date MLR Interest Reduction in Balance of lease

Receivable Receivable
Revenue

$ $ $ $

1 July 2015 476 514

30 June 2016 150 000 28 591 121 409 355 105

30 June 2017 150 000 21 306 128 694 226 411

30 June 2018 150 000 13 589 136 411 90 000

30 June 2018 90 000 90 000 -

540 000 63 486 476 514 -

2. Accounting for the lease in the books of Tyres Ltd (lessor)

Journal Entries

1 July 2015

Processing plant Dr 467 100

Cash Cr 467 100

(Purchase of plant from Squeal Ltd)

Lease receivable Dr 467 100

Processing plant Cr 467 100

(Recognition of lease agreement)

Lease receivable Dr 9 414

Cash Cr 9 414

(Payment of initial direct costs)

30 June 2016

Cash Dr 165 000

Lease receivable Cr 121 409

Interest revenue Cr 28 591

Reimbursement revenue Cr 15 000

(First lease receipt in arrears)

Maintenance expense Dr 15 000

Cash/Payable Cr 15 000

(Maintenance costs incurred)

30 June 2017
Cash Dr 165 000

Lease receivable Cr 128 694

Interest revenue Cr 21 306

Reimbursement revenue Cr 15 000

(Second lease receipt in arrears)

Maintenance expense Dr 15 000

Cash/Payable Cr 15 000

(Maintenance costs incurred)

30 June 2018

Cash Dr 165 000

Lease receivable Cr 136 411

Interest revenue Cr 13 589

Reimbursement revenue Cr 15 000

(Third lease receipt in arrears)

Maintenance expense Dr 15 000

Cash/Payable Cr 15 000

(Maintenance costs incurred)

Processing plant Dr 90 000

Lease receivable Cr 90 000

(Return of processing plant)

PART E – LESSOR A MANUFACTURER/DEALER

If Tyres Ltd had manufactured the plant at cost of $400 000 then this would not be a sale and
leaseback transaction. Accordingly, the following changes to the answer would occur:

• Tyres Ltd (lessor) would record the initial direct costs as an expense
• The lease receivable recorded by Tyres Ltd would revert back to the fair value of $467 100 and the
interest rate implicit in the lease would change to approx. 7%*.

* $150 000 x 2.6243 + $90 000 x 0.8163

= $393 645 + $73 467

= $467 112

• The initial entry to record the lease in Tyres Ltd’s books would change to:

Lease receivable Dr 467 100

Sales revenue Cr *442 623

Cost of sales Dr **375 523

Processing plant Cr 400 000

(Initial recognition of lease and recording sale of plant)

* Using 7%, PV of MLP = $150 000 x 2.6243 + $60 000 x 0.8163

**[$400 000 (cost of plant) less $24 489 (PV of unguaranteed residual value)

= $30 000 x 0.8163]

Lease establishment expense Dr 9 414

Cash Cr 9 414

(Payment of establishment costs)

Thus, a profit on ‘sale’ of $67 100 (net of initial direct costs) would be recorded.

• Squeal Ltd (lessee) would have no ‘sale’ of plant entries and would simply record the leased
asset/lease liability. As a result there would be no amortisation of the gain over the lease term.

Question 10.14 Accounting for a finance lease by manufacturer lessor

Loot Ltd manufactures specialised moulding machinery for both sale and lease. On 1 July
2015, Loot Ltd leased a machine to Hotinpursuit Ltd, incurring $1500 in costs to prepare
and execute the lease document. The machine being leased cost Loot Ltd $195 000 to make
and its fair value at 1 July 2015 is considered to be $212 515. The terms of the lease agreement
are as follows:

Lease term commencing on 1 July 2015 5 years

Annual lease payment commencing on 1 July $57 500
2016
Estimated useful life of machine (scrap value 8 years
$2500)
Estimated residual value of machine at end of $37 000
lease term
Residual value guaranteed by Hotinpursuit $25 000
Ltd
Interest rate implicit in the lease 10%
The lease is classified as a finance lease.

The annual lease payment includes an amount of $7500 to cover annual maintenance and
insurance costs. Actual executory costs incurred for each of the 5 years were:
2015–16 $ 7 200
2016–17 7 700
2017–18 7 800
2018–19 7 100
2019–20 7 000

Hotinpursuit Ltd may cancel the lease but will incur a penalty equivalent to 2 years
payments if it does so. Hotinpursuit 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
A. Prepare a schedule of lease receipts for Loot Ltd.
B. Prepare the journal entries of Loot Ltd in respect of the finance lease.
C. Assume the lease is classified as an operating lease and Loot Ltd paid Hotinpursuit Ltd
$50 000 on 1 July 2015 to enter into the agreement. Prepare the journal entries of Loot
Ltd in respect of the operating lease from 1 July 2015 to 1 July 2017.
Loot Ltd is a manufacturer/dealer lessor. Hence its initial direct costs for the lease are treated
as part of the sale transaction rather than part of the lease transaction.

PART A – SCHEDULE OF LEASE RECEIPTS

PV of MLP = 96.5% of FV at the date of the lease inception

[$50 000 (3.7908) + $25 000(.6209) = $189 540 + $15 523

= $205 063

PV/FV = $205 063/$212 515

= 96.5%

PV of UGRV = $12 000 x 0.6209

= $7 450

Loot Ltd (Lessor)

Schedule of Lease Receipts

Year ending MLR Interest Reduction of Balance of

revenue receivable receivable

(10%)

1/7/15 212 515

1/7/16 50 000 21 252 28 748 183 767

1/7/17 50 000 18 377 31 623 152 144

1/7/18 50 000 15 214 34 786 117 358

1/7/19 50 000 11 736 38 264 79 094

1/7/20 50 000 7 906 42 094 37 000

1/7/20 37 000 - 37 000 -

287 000 74 485 212 515

PART B – JOURNAL ENTRIES OF LESSOR FOR FINANCE LEASE

1 July 2015

Lease receivable Dr 212 515

Cost of sales Dr 187 550

Inventory Cr 195 000

Sales revenue Cr 205 065

Lease arrangement expense Dr 1 500

Cash Cr 1 500

30 June 2016

Executory costs expense Dr 7 200

Cash/Payable Cr 7 200

Interest receivable Dr 21 252

Interest revenue Cr 21 252

Receivable for executory costs Dr 7 500

Reimbursement revenue Cr 7 500

1 July 2016
Cash Dr 57 500

Interest receivable Cr 21 252

Lease receivable Cr 28 748

Receivable for executory costs Cr 7 500

30 June 2017

Executory costs expense Dr 7 700

Cash/Payable Cr 7 700

Interest receivable Dr 18 377

Interest revenue Cr 18 377

Receivable for executory costs Dr 7 500

Reimbursement revenue Cr 7 500

1 July 2017

Cash Dr 57 500

Interest receivable Cr 18 377

Lease receivable Cr 31 623

Receivable for executory costs Cr 7 500

30 June 2018

Executory costs expense Dr 7 800

Cash/Payable Cr 7 800

Interest receivable Dr 15 214

Interest revenue Cr 15 214

Receivable for executory costs Dr 7 500

Reimbursement revenue Cr 7 500

1 July 2018

Cash Dr 57 500

Interest receivable Cr 15 214

Lease receivable Cr 34 786

Receivable for executory costs Cr 7 500

30 June 2019

Executory costs expense Dr 7 100

Cash/Payable Cr 7 100

Interest receivable Dr 11 736

Interest revenue Cr 11 736

Receivable for executory costs Dr 7 500

Reimbursement revenue Cr 7 500

1 July 2019

Cash Dr 57 500

Interest receivable Cr 11 736

Lease receivable Cr 38 264

Receivable for executory costs Cr 7 500

30 June 2020
Executory costs expense Dr 7 000

Cash/Payable Cr 7 000

Interest receivable Dr 7 906

Interest revenue Cr 7 906

Receivable for executory costs Dr 7 500

Rimbursement revenue Cr 7 500

1 July 2020

Cash Dr 57 500

Interest receivable Cr 7 906

Lease receivable Cr 42 094

Receivable for executory costs Cr 7 500

Inventory Dr 37 000

Lease receivable Cr 37 000

PART C – JOURNAL ENTRIES OF LESSOR FOR OPERATING LEASE

1 July 2015

Lease arrangement expense Dr 1 500

Cash Cr 1 500

Lease incentive asset Dr 50 000

Cash Cr 50 000

30 June 2016
Rent and other receivable Dr 57 500

Rent revenue Cr 40 000

Reimbursement revenue Cr 7 500

Lease incentive asset Cr 10 000

Executory costs expense Dr 7 200

Cash/Payable Cr 7 200

Depreciation expense Dr 24 062

Accumulated depreciation Cr 24 062

[(195 000 – 2 500) ÷ 8]

1 July 2016

Cash Dr 57 500

Rent and other receivable Cr 57 500

30 June 2017

Rent and other receivable Dr 57 500

Rent revenue Cr 40 000

Reimbursement revenue Cr 7 500

Lease incentive asset Cr 10 000

Executory costs expense Dr 7 700

Cash/Payable Cr 7 700

Depreciation expense Dr 24 062

Accumulated depreciation Cr 24 062

[(195 000 – 2 500) ÷ 8]

1 July 2017

Cash Dr 57 500

Rent and other receivable Cr 57 500