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I have come across the question in the BPP textbook which i do not understand:
On 1st April 20×7, Fino increased the operating capacity of its plant. Due to a lack of 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 its manufacturer. The lease required 4 annual payments in advance of $100, 000 each commencing on 1st april 20×7. The rate of interest implicit in the lease is 10%. The plant would have a useful life of four years and be scrapped at the end of period.
What amount should be shown under non current liabilities at 30 september 20×7 in respect of this plant.
What i would do, is 350000 – 100000=250000
interest: 250000*10%*6/12=12500
Balance at 30 sept 07 would be 262500.I would then work out 10% of 262500 add that and then take away the 100000 and that answer compare to 262500 o give the non current liabilites
However the answer here is 175000 because interest of only a half a year was added with 100000 deducted.
I am rather confused about this
Many thanks in advance
After the first $100,000 had been paid, only $250,000 capital was outstanding
I think the issue here is how to compute the lease interest
The interest on $250,000 @ 10% for 1 year is $25,000
That is split into 2 halves so that we can arrive at the current liability for interest as at the year end of 30 September, 2008 ($12,500)
What you are now doing is charging interest on that interest by calculating 10% for half a year on $262,500 ($250,000 capital + the half year’s interest up to 30 September, 2008) whereas it should simply be the ‘other’ half of the $25,000 originally calculated
When that second $100,000 is paid on 1 April, 2008, it settles lease interest of $25,000 and therefore pays only $75,000 capital leaving only $175,000 capital outstanding as at 30 September, 2008
So, in the financial statements for the year ended 30 September, 2007, the non-current liability is that figure of $175,000
OK?
Thank you.
However, the question asks for the year to 30 september. So why are we doing a half years interest payment?
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