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On 1 January 20X4 Badger entered into a lease agreement to lease an item of machinery for 4 years with rentals of $210,000 payable annually in arrears. The asset has a useful life of 5 years and at the end of the lease term legal ownership will pass to Badger. The present value of the lease payments at the inception of the lease was $635,000 and the interest rate implicit in the lease is 12.2%. For the year ended 31 December 20X4 Badger accounted for this lease by recording the payment of $210,000 as an operating expense. This treatment was discovered during 20X5, after the financial statements for 20X4 had been finalised.
In the statement of changes in equity for the year ended 31 December 20X5 what adjustment will be necessary to retained earnings brought forward?A $5,530 credit
B $132,530 credit
C $210,000 debit
D $Nil 82Answer: A
I understand the answer to the question and how they arrived at it. What’s bothering me, is how am I to assume that Depreciation wasn’t recorded? The question only states that the payment was incorrectly recorded, and I don’t see how that affects depreciation or suggest that depreciation was not recorded as well. I am aware that normally you would have to account for depreciation of the Asset at the 5 years (since ownership passes). Can you please assist with clearing this up for me?
Looking forward to your response.
Hi,
It is a tricky one but if they’ve recorded the payment as an expense then they are in essence treating is a small value asset and won’t have recorded either the lease liability or the asset. If the asset has not been recorded then there would have been no depreciation recorded and so we would need to retrospectively record it.
Hope that clears it up.
Thanks
Yes it does. Thanks a lot! Didn’t consider it being treated as a small value asset from their point of view.
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