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A lessor, ABC, leases an asset, which it purchased for 4400$, to XYZ under a finance lease. It estimates that its residual value after five years will be 400$ and after seven years will be zero.
The lease is for five years at a rental of 600$ per half year in advance, with an option of two more years at nominal rental. The lease commences an 1 January 2016. The directors of XYZ consider that the asset has a useful life of seven years. The finance charge is to be allocated using the actuarial method, assuming that the interest rate implicit in the lease is 7.68 %. Title to the asset will pass to XYZ at the end of seven years if the option is exercised. It is likely that it will be.Required:
Show the relevant extracts from the financial statements of XYZ for the year ended 31 Dec. 2016.And which part are you stuck with?
Is the printed solution unclear or do you think that it may be incorrect?
Hi Sir
Printed solution is a little bit unclear to me.
Capital due for period at 31 Dec is 2803$ but my answer was 3492$ and it is still unclear to me.Hi
I can see where you have got $3,492 and I believe that you have made an error of principle in arriving at that figure
You have taken:
4,400 “borrowed” on 1.01.16
( 600) paid on 1.01.16
3,800
( 600) paid on 1.07.16
3,200and added interest at 7.68% based on 3,800
3,800 @7.68% = 291.84 which, when added to 3,200 arrives at 3,491.84 (your figure)
But interest at 7.68% should only be applied (in my view) to 3,800 for half a year and that computes as 145.92
So that payment of 600 on 1 July, 2016 pays 145.92 interest and the rest (454.08) is a capital repayment to be deducted from 3,800 leaving 3,345.92 to carry forward at 1 July, 2016
Interest for half a year on that 3,345.92 at 7.68% = 128.48 so total interest for the year is 145.92 + 128.48 = 274.40 and not 291.84 which is your figure
But your question concerns the capital amount outstanding at the end of the year, the day before our next 600 payment and, according to me, that figure is 3,345.92 (interest is also outstanding in the sum of 128.48)
That figure of 3,345.92 needs to be sub-divided into current and long term liabilities. Capital outstanding at 31 December, 2017 is 2,384.78 so that amount is the long term liability as at 31 December, 2016 and the difference (3,345.92 – 2,384.78) 963.14 is the current element of the total liability as at 31 December, 2016 of 3,345.92
Now, to the printed solution! One or other of you and the publisher has made a mistake! I can say this with certainty because we “borrowed” 4,400 on 1 January, 2016, we paid 600 on the same day, we paid 600 on 1 July, 2016 so in total in 2016 we paid 1,200 against that borrowed figure of 4,400. If that 1,200 included NO interest whatsoever, that would bring the borrowed amount down to 3,200.
It cannot possibly be 2,803
But, of course, the 1,200 DOES pay off the interest accrued
In addition, the capital amount outstanding as at 31 December, 2016 should not be shown as including the second half year’s interest – because that’s interest, not capital
If I had to put money on this, my guess is that you have copied incorrectly either the question or the answer, but it’s possible that the publisher has made a mistake (it’s not unheard of!)
Is that better?
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