Finance Lease Calculations

I shall not answer the BPP question – the answer should be followable from the BPP text and hopefully my answer to your question about payments in advance / in arrears will be enough to help!

Payments in arrears:- Say the payment intervals are one year (it’s easier to explain for annual payments). A lease is (typically in exams, but not always) signed on 1 January – or the start of the accounting year. Payments in arrears will be on 31 December. When the first installment is paid on 31 December, that payment settles the lease interest together with some part of the capital amount outstanding. Calculate the extent of the lease interest, the rest is capital. On the Income Statement, within Finance Charges, the interest element is found. On the Statement of Financial Position there is the capital amount outstanding, subdivided into current and long term. OK so far?

For payments in advance, payments will be made on the day the lease is signed and then on each anniversary thereafter. So second payment is on 1 January the year after. But that means that on 31 December, the day before we make the second payment, the amounts outstanding are not just the capital amount (current and long term) but also the interest that has accrued over the year since the lease was signed. Again, calculate the interest, deduct from the installment amount and that will give you two figures for the Financial Position as well as one figure for the Income Statement. The two for the Financial Position are the current liabilities for (1) the accrued interest and (2) the current liability for the capital.

The one for the Income Statement is the figure to include within Finance Charges – finance lease interest relating to the year (matching concept)

If you now deduct that capital current liability from the total capital liability, that will give you the long term liability – again, shown on the Financial Position.

Is that ok? Apply the principles to the Evans question and check your effort against the BPP answer. Reconcile the difference. You could always try the question from the opentuition course notes called Giedrius and Giedruola – the answers are towards the end of the course notes

The capital amount outstanding as at 30 September is $52,974

Interest outstanding at that date is $1,059

We need to split the $52,974 into long-term and current liabilities. This is going to involve you working through the payments schedule for another 4 instalments (inclusive of the instalment paid on 1 October) until you arrive at the amount outstanding immediately after the instalment paid on 1 July next year. When you have arrived at the figure, that represents the long-term liability as at this 30 September and, when deducted from $52,974, will give you the current liability as at this September.

But of course that current liability is only the capital obligation. There is also the interest accrued to 30 September and not paid until 1 October $1,059

Depreciation should be charged over the shorter of the lease term and the estimated useful life of the asset. However, where there is an option for the lessee to extend the lease on favourable terms (either a nominal annual rental or even no rental at all!) and it is likely at the inception (a fancy word for “start”) of the lease that that option will be taken up, then depreciation will be over the estimated useful life of the asset.

That appears to be the case here

OK?