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Hi tutor,
In a sales and leaseback question, should the profit on disposal be spread evenly over the lease term? Should the depreciation charge be calculated using the higher of or lower of fair value and carrying amount then?
[taken from Kaplan revision kit MCQ 57]
On 1 July 20X6, sideshow sold a piece of property for $2m and leased it back under a 5 year operating lease, paying $150,000 a year. The sale value and rentals were at the market value. The carrying amount of property on 1 January was $1,600,000 and it had a remaining useful life of 20 years.What entries would be made in sideshow’s statement of profit or loss for the year ended 31 December 20X6?
The model answer: profit on disposal of $440,000, depreciation expense of $40,000, rent expense of $75,000; which I got it right (only because all the other options were obviously wrong)
In the BPP study text, the profit on disposal was spread out evenly over the lease term (except this was a finance lease). The depreciation expense was also calculated using the fair value rather than the carrying amount (fair value is higher than carrying amount).
Hope you could help me on this, thanks 🙂
I’ll probably just type out the question from BPP study text too:
Capital Co entered into a sale and finance lease on 1 April 20X7. It sold a lathe with a carrying amount of $300,00 for $400,00 and leased it back over a 5 year period. The finance lease provided for five annual payments in arrears of $90,000. The rate of interest implicit in the lease is 5%.
Statement of profit or loss
Profit on disposal ($100,000/5) = $20,000
Depreciation ($400,000/5) = 80,000
Interest 20,000If you were to look at the P2 course notes and in particular the chapter on leases, you’ll find an example showing carrying value, fair value and sale value and their inter-relationship
Check that out and see if it makes any sense to you
Then come back to me if you’re still in the dark
Hi Mike, the P2 lecture was indeed helpful, thanks 🙂
Just to want make sure if I’ve gotten everything right:
Under operating leaseback:
If proceeds>fair value, we use fair value to calculate the profit on disposal, and recognize the excess amount of proceeds as loan in the SOFP. This should be treated as a non current liability, and will be paid over the lease period, with the balance amount of rental payment (actual rentals paid less market rental rate), right? What should I call this loan? Operating leaseback loan?Under finance leaseback the profit on disposal is spread evenly over the lease period, while under operating leaseback the profit on disposal is recognized immediately in the SOPL. Is this correct?
Hoping to hear from you again 🙂
‘What should I call this loan? Operating leaseback loan?’ — yes, if you want. That will do nicely
‘Is this correct?’ — sounds good to me!
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