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Hello,
I was solving the question below and i really don’t understand the tutor’s workings. Please see the question below:A company has the option of buying a machine outright for a cash price of $14,275 or leasing it on a financial lease paying $5,000 at the end of every year for 4 years. The rate of interest implicit in the lease arrangement is 15% per annum.
Required: Show how the company should account for this lease in its Statement of Profit or Loss and Statement of Financial Position for the first year. Show full workings.
Please see the tutor’s calculations below:
Price structure
Lease price 5,000 × 4 instalments 20,000
Cash price (14,275)
______
Total interest 5,725
______The tutor then went on to calculate the movement in the liability using the $14,275 as his opening balance and making subsequent deductions of the interest at 15% as well as the annual payments of $5,000.
I am really confused by this as i understand the question to mean that the upfront cash payment of $14,275 was given as an OPTION compared to the annual settlements of $5,000.
Please I am eagerly awaiting your reply. 🙂
“the upfront cash payment of $14,275 was given as an OPTION”
I don’t see an upfront payment of $5,000!
The question states that “A company has the option of buying a machine …. ”
The use of the word “option” merely indicates that the company has a choice as to whether it wishes to buy outright or does it wish to enter a finance lease agreement
Maybe “choice” would have been a better word to use instead of “option”
Okay. Thank you. So that means that the company could either make a one time payment of $14,275 or make annual payments of $5,000 with a 15% interest rate right?
Now I’m confused as to why we are working with both payment options i.e. the $14,275 and the $5,000. Aren’t we supposed to work them both separately?
I think I’m confusing myself. Please help!“So that means that the company could either make a one time payment of $14,275 or make annual payments of $5,000 with a 15% interest rate right?”
Correct
The information about $14,275 is simply telling you the cash price of the asset
As it happens (this is a poor example!) the present value of $5,000 payable annually in arrears for 4 years where there is a 15% implicit interest rate is … $14,274.81807 (to 5 decimal places)
“Aren’t we supposed to work them both separately?”
This comment I don’t understand!
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