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Hi Mike,
I need your help on this question, taken from Kaplan revision kit, question 55.
On 1st January 2014 a company entered into a lease agreement to lease an item of machinery for 4 years with rentals of $210,000 payable 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 the company. The fair value of the asset at the inception of the lease was $635,000 and the interest rate implicit in the lease is 12.2%. For the year ended 31 December 2014 the company has accounted for this lease as an operating lease and recorded the payment of $210,000 as an operating expense. This treatment was discovered during 2015.
In accordance with IAS 17 what will the adjustment to retained earnings brought forward be?
Answer:
Reverse operating treatment of $210,000
Include depreciation of $127,000 (635,000/5)
Include finance cost of $77,470This would result in a $5,530 credit adjustment.
I got everything else except the depreciation calculation. Why is the depreciation charge calculated over 5 years? Shouldn’t it be calculated over the shorter of the useful economic life of the asset and the lease term, which in this case, over 4 years?
This is tricky!
Ownership passes to our company at the end of the lease term and the asset still has one more year of useful life after the 4 year lease period
So we lease it for 4 years and own it outright for a further year … so depreciation is over 5 years
OK?
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