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When the lease payment is paid in advance, the current liability is the rent itself. But if lease payment is paid in arrear at the end of the year, the current liability is rent less finance charge(of next year).
why is this treatment different?Sometimes Steve Scott will ask a question where the lease payments are in, say, end September and the year end in December. So great care is needed to understand the basis of the computation of the liabilities!
As at the year end there could be capital together with interest outstanding or there could be just capital outstanding. Let’s assume that the installment is paid NOT on 31 December ( 31 December year end ), so there has been a period of time since the previous installment payment. The amounts outstanding will be the interest accrued since the previous installment payment up to the year end, calculated on a pro-rata basis, and the capital amount payable within the twelve months after the
year end. By deducting this capital amount from the capital outstanding immediately after the previous installment payment, that will leave you with the capital outstanding which is payable more than 12 months away.If you follow these basic principles, you should be able to calculate the amounts outstanding.
If the previous installment WAS paid on 31 December, the amount of the obligation needs to be split into current and deferred, but that should be a straightforward exercise – calculate the capital element to be paid off during the next 12 months, and that’s the current liability and no interest outstanding. Deduct that capital liability from the total liability as at the year end and the resulting amount is the deferred liability
Clear?
sir, you didnt get my doubt.great thanks for the time, what you explained is the right thing. same matter i was looking at it in different angle.
when the lease payment is on dec 31. then we have to find the difference of liabilities of this year and the next year. very easy to calculate. but the answer we get is rent minus finance interest of next year. see, the only amount we pay is rent. actually, when we find the difference what we get is rent minus finance charge of next year.
if the rent was paid at the begining of the year then the current liability is just the rent. no calculation required here. just put rent as current liability.
No, I believe that you are incorrect – based purely on your last sentence! Where installments are paid on January 1, there will be a liability not only for the capital amount outstanding but also for the interest accrued since the last installment payment.
And the liability will not be “just the rent”. The current liability in the situation where rent is paid on January 1 will be “next installment minus interest accrued since last installment payment”
sir,
case 1
interest 10%capital b/f
69,738
lease payment
(20,000)
capital outstanding—-49,738
interest
4,974
capital c/f
54,712
lease
(20,000)
capital outstanding —34,712
interest
3471
capital c/f
38183then current liability is
54712-(38183-3471)= 20,000
that is same as lease payment.
current liability=lease payment.case 2
interest 15%capital b/f
5,710
interest
856
capital outstanding —6566
lease
(2000)
capital c/f
4566
interest
685
capital outstanding —5251
lease
(2000)
capital c/f
3251then current liability=4566-3251=1315
also, 1315 =2000-685 .
current liability=lease amount – finance interest.if you take 10% loan, current liability is the payment we make. if you think in that angle , case 2 is not straightforward.
but if you take current liablities as difference of capital at year end, then case 1 is not straightforward.
i hope you understand what i am depicting.Remember interest is charged for time value.. Lets say u took 100 from a bank and return after 1 hour the same amount the bank won’t charge you interest..
Similarly when rent is paid in arrears then the principle which was outstanding at the year end was outstanding for the whole year and interest was paid for that period..
now when interest is paid then at year end there is no liability on you to pay interest the only liability you have right now at year end is the principle i.e if you repay the whole amount immediately you have to just pay principle not the future interest because it has not yet accrued..1 🙂 hope i interpreted your question correctly..
Now a $ 1 million sentence
the interest portion of your future rentals in case the rent is paid at accounting year end (i.e in arrears) is your contingent liability only coz there is no present obligation however there is past event and probable outflow of cash and thats y its just disclosed in the notes to the financial statementsI’ll post a response tomorrow – I’m just about to go out for the evening but, from a quick look at your post, it seems to me that you need to sort out what constitutes capital and what constitutes interest. That’s the bit which is causing your confusion!
Hi again
Let me see if I can set this out for you in an easily understood format because, if I can’t, I shall have to do a recording of it as though it were a lecture 🙁
I want to start with the 10% case with a capital balance brought forward of 49,738 as at 1 January, immediately after the most recent instalment payment. This 49,738 is borrowed for a year and accrues interest at 10% amounting to 4,974. Throughout this year, the capital o/s will be 49,738. Now, at 31 December ( remember, the next instalment will not be paid until “tomorrow” ) there are two amounts outstanding. First, there is the accrued interest for the year of 4,974 and second there is the capital outstanding of 49,738. This o/s capital needs to be subdivided for the Statement of Financial Position into the current element and the non-current ( long term ) element. So, we have THREE liabilities on the S of F P, two current liabilities and one long term liability. The current liabilities are 4,974 interest for the year just finished and 15,026 which is the amount by which the capital outstanding will be reduced when we pay our 20,000 instalment “tomorrow”. The long term liability will be the 49,738 capital o/s brought forward minus the 15,026 which we shall settle tomorrow. So long term debt will be 34,712.
Now, let’s pay that 20,000 tomorrow on 1 January. So, 49,738 + interest of 4,974 – payment of 20,000 means that, as at 1 January, I have 34,712 capital o/s. And that remains the position for twelve months. On 31 December, I calculate that interest accrued and not paid for the year is 10% of 34,712 ie 3,471. This o/s interest will be paid “tomorrow” together with an amount of capital when I pay the next 20,000. As at 31 December, there will be THREE items on the SoFP. Accrued interest of 3,471, and a current liability and long term liability which two together will add up to the 34,712. The current element will be the amount of capital paid off tomorrow, that is 20,000 – 3,471 ie 16,529. Therefore the long term element will be 34,712 – 16,529 = 18,183.If you want to view the current liability as simply “the next instalment” well, yes, ok, it is. But really you would be safer to appreciate the difference between accrued interest not yet paid as at the year end and the capital amount which will be settled by the next instalment. Furthermore, if Steve Scott asks this topic again, your way of thinking will produce an incorrect answer ( I think! )
Now, the second scenario with 15% interest
I’ll start with the 5,710 per your post. This is the capital amount o/s brought forward from last year where we made the most recent instalment payment on 31 December last year. That means that there is no accrued interest brought forward because it was paid off in the instalment which we paid “yesterday”.
A complete year goes by and, at 31 December, we calculate how much finance lease interest relates to the year just finished. In your example, it is 15% of 5,710 = 856. We are still at work on 31 December and we need to pay this year’s instalment of 2,000. As we pay that amount, 856 is in settlement of the interest and 1,144 is to settle part of the capital amount o/s. On the SoFP at 31 December, there will be only TWO amounts. There will be a current liability and a long term liability. 5,710 + 856 – 2,000 = 4,566. This is the amount of the TOTAL liability and needs to be sub-divided ( the current element is 1,315, long term is 3,251, and I’ll show you how to arrive at those two figures in a moment )
4,566 is the amount o/s brought forward and nothing happens for a year. Then, on 31 December, we calculate how much is the finance lease interest for the year just finishing and the amount is 4,566 * 15% = 685. now, let’s pay this year’s instalment of 2,000. The first 685 of this 2,000 is paid in settlement of this year’s interest and only 1,315 is paid against the capital amount o/s. So now the capital o/s has been reduced to 4,566 – 1,315 = 3,251 o/s as at 31 December. This figure too needs to be sub-divided into current and long term.
Remember at the end of last year there was an amount of 4,566 o/s? Now the equivalent figure a year later is 3,251. That means that, at the end of last year there must have been a current liability of 4,566 – 3,251 = 1,315. therefore, last year’s long term liability must have been 4,566 – 1,315 = 3,251. But there is NO finance lease interest outstanding at the year end because it is fully paid within each instalment payment of 2,000 made on 31 December.
I do hope that you have understood all this because your way of thinking will inevitably lead you astray, particularly in the topics of cash flow statements (question 3 ) and in the preparation of financial statement questions ( question 2 )
However, if you still are struggling to understand, do post again!
Okay, i understood. I was trying to find how this figures are coming. after many drills i got the idea.
when we pay installment at year end, then it includes interest accrued of the year.when we pay installment at begining of year then it includes interest accrued of the previous year and this interest accrued become part of current liability in previous year accounting.
in either case, installment we pay includes a portion of capital and the interest accrued.
current liability is not just the installment we are going to make next year. I took current liability is the amount that will be paid in coming 12 months.
all that i understood.if i put my doubt in other word, accounting period ends at 31st dec. then current liability is the amt that we are going to make within 12 months. and we make actually entire installment. but here, if they pay at the year end, current liability is not he installment amount. so a doubt came? why it is so. it was bcoz , interest accured of the next year should not take into accounting as current liability this year. now, i got it.
thanks a lot, sir Mike, you took lot of effort esp with lengthy explanation to clear out my doubts.
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