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On 1st January 20×4 badger co entered into a lease agreement to lease an item of machinery for 4 years with rentals of $210000 payables 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 co. The fair value of the asset at the inception of the lease was $ 635000 and the interest rate implicit in the lease is 12.2%. For the year ended 31st december 20×4 badger co has accounted for this lease as an operating lease and recorded the payement of $210000 as an operating expense. This treatment was discovered during 20×5.
What will the adjustment to retained earnings b/fwd be?
A) $5530 credit
B) $132530 credit
C) $210000 debit
D) $NilMy question is this question is from Kaplan kit under the heading of IAS 17 LEASE.
However, I saw your video related to lease and also read chapter IAS 17 lease BPP text but didn’t find this type of question or theory related to operating lease and retained earning can you please clarify me that from which topic does this question belongsThe lease is clearly not an operating lease – it’s a finance lease
So you need to calculate the correct amount of finance lease interest + the correct amount of depreciation to find exactly how much should have been expensed through profit or loss last year
Then make the necessary adjustment
Ok?
Ok
fair value $635000
interest (12.2%) $77470 ( finance cost)
_________
$712470
Instalment $21000( obligation)
________
Bal outstanding $502470Depreciation : $635000
__________= $127000
5 years
I have calculated it please can you put these amount in double entry form
As I am getting little bit confused.First we need to credit the retained earnings brought forward to cancel the incorrectly treated $210,000 last year’s instalment payment
Then we need to expense the finance cost of $77,470 and the depreciation of $127,000(your calculations, not checked by me)
So expenses of $204,470 and a credit of $210,000 gives a net credit (addition) to the retained earnings brought forward of $5,530
Ok?
Ok but can you do double entries for me I mean what’s credit and what’s debit
I have done!
I start the reply with ‘First we need to credit …’
1) Dr operating lease expense 210,000
Cr retained earnings brought forward0210,0002) Dr retained earnings brought forward 77,470 finance lease interest
Cr obligations under finance lease account 77,4703) Dr retained earnings brought forward 127,000
Cr accumulated depreciation 127,000Also need to capitalise the asset and create the obligation account
4) Dr TNCA 635,000
Cr obligations under finance lease account 635,000Ok?
Sir
According to above question which I wrote above badge co.
The asset has 5 years of useful life where as the lease years is of 4 years
Which means lease years is shorter than useful then why we didn’t calculated depreciation on the basis of lease yearsBut at the end of the lease term the legal ownership of the asset will pass to Badger
If we have taken an asset on operating lease then do we have to take out depreciation expense every year
Absolutely NOT
This is not, neither in law nor in substance, our asset so we will not depreciate it (but watch this space for the soon to be examinable new rules on leasing)
They won’t apply to December 2016!
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