On 1 July 2007 Sadex had entered into two leasing contracts, effective from that

Question

On 1 July 2007 Sadex had entered into two leasing contracts, effective from that date, details of which are as follows:

Contract 1

An operating lease for mobile lifting equipment for use in the finished goods warehouse, at an annual rental of £45,000 payable in advance, for a period of six years.

Contract 2

A finance lease for plant, at an annual rental of £208,000 payable in advance, for a period of five years. The initial fair value of the plant was £800,000. Depreciation is provided at the rate of 20% per annum on a straight line basis, assuming no residual value. The interest rate implicit in the lease is 15.15%

Required

Show how the two leases would be reflected in the financial statements of Sadex for the years ended 30 June 2008 and 2009. Notes to the accounts are not required.

Explanation / Answer

Contract 1:

For the year ended June 2008.

For operating lease only rent expense is recorded, no asset will be part of the books.

Hence rent expense for the year 45000 reported. and an amount of 45000 is payable in advance which will be shown as prepaid expenses in the balancesheet.

For the year ended June 2009.

For operating lease only rent expense is recorded, no asset will be part of the books.

Hence rent expense for the year 45000 reported. and an amount of 45000 is payable in advance which will be shown as prepaid expenses in the balancesheet.

Contract 2:

For the year ended June 2008:

At the inception of the lease, asset of 800000 is recorded lease obligation of 800000-208000= 592000 is recorded.

For the year depreciation= 800000*20%= 160000 recorded.

Interest expense= 592000*15.15%= 89688 is recorded.

By end of year a payment of another 208000 first adjusted for interest expense of 89688 and then reduces lease obligation by 208000-89688= 118312, hence carrying amount of lease obligation reduces to 592000-118312= 473688

In the financial statements:

In income statement:

Depreciatin expense: 160000

Interest expnese: 89688 is reported

In balancesheet:

Net book value of asset: 640000

Lease obligation: 473688 is reported

For the year ended June 2009:

For the year depreciation= 800000*20%= 160000 recorded.

Interest expense= 473688*15.15%= 71764 is recorded.

By end of year a payment of another 208000 first adjusted for interest expense of 71764 and then reduces lease obligation by 208000-71764= 136236, hence carrying amount of lease obligation reduces to 473688-136236= 337452

In the financial statements:

In income statement:

Depreciatin expense: 160000

Interest expnese: 71764 is reported

In balancesheet:

Net book value of asset: 480000

Lease obligation: 337452 is reported

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