FAC2601_Graded_questions_with_solutions_GAAP

FAC2601_Graded_questions_with_solutions_GAAP Solutions to GAAP : Graded Questions Leases Kolitz & Service, 2011 Chapter 20: Page 1 Solution 20.1 a) Discussion IAS 17, paragraph 10 provides the following situations where the classification of a lease agreement is in question: a) Does ownership of the building transfer to West Ltd by the end of the lease? No  No evidence of this is provided (assume no) b) Does West Ltd have an option to purchase the building at a price expected to be lower than the fair value at the date the option became exercisable?  No evidence of this is provided (assume no) No c) Is the lease term for the major part of the economic life of the building?  The lease term is for 8 years whereas the useful life is 20 years. No d) At the inception of the lease, does the present value of the minimum lease payments amount to at least substantially all of the fair value of the leased building?  The total of the actual lease payments is only C372 000 (5 years x C5 000 x 12 months + 3 years x C2 000 x 12 months). The present value thereof would be even less. The present value of the actual lease payments would therefore not constitute ‘substantially all of the fair value’, being C1 000 000. No e) Is the building of such a specialised nature that only West Ltd can use it without major modifications?  No evidence of this is provided (assume no) No Since none of the criteria have been met, the risks and rewards associated with ownership have not passed from East Ltd to West Ltd. The lease over the building should therefore be classified as an operating lease. Solutions to GAAP : Graded Questions Leases Kolitz & Service, 2011 Chapter 20: Page 2 Solution 20.1 continued ... b) Journals Debit Credit 31 December 20X0 Rent expense 3 875 x 12 months 46 500 Prepaid expenses Balancing 13 500 Bank 60 000 Rental paid: partly incurred Working 1: Straight lining of lease payments Year Monthly rental Per annum Total 372 000 372 000÷ (8x 12) = 3 875 is to be recognised as the rental expense each month