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On 1 April 2007, Fino increased the operating capacity of its plant. Due to a lack of liquid funds it was unable to buy the required plant which had a cost of $350,000. On the recommendation of the finance director, Fino entered into an agreement to lease the plant from the manufacturer. The lease required four annual payments in advance of $100,000 each commencing on 1 April 2007. The plant would have a useful life of four years and would be scrapped at the end of this period. The finance director, believing the lease to be an operating lease, commented that the agreement would improve the company’s return on capital employed (compared to outright purchase of the plant).
Answer
Cost 1.4.07
350,000
1.4.07 deposit
(100,000
Balance 1.4.07 )
250,000
Interest to 30.9.07 (250,000 × 10% × 6/12)
Balance 30.9.07
12,500
262,500
Interest to 1.4.08 (250,000 × 10% × 6/12)
12,500
1.4.08 payment
(100,000
Capital balance due 30.9.08 )
175,000I cannot understand why in the second year he used 250,000 and not 262,500…
Please help
I presume that the company’s year end is September 30. This isn’t the second “year” you’re looking at. The interest for the accounting year ended 30 September, 2007 is $12,500. Another 6 months’ interest is $12,500 so, at 31 March 2008 there is an interest-inclusive amount due of $275,000 and on 1 April $100,000 is paid. Of that $100,000 paid, $25,000 is paying the interest which has accrued since 1 April 2007 and $75,000 is repaying part of the $250,000 capital amount outstanding as at 1 April, 2007 immediately after the first “instalment” was paid
OK?
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