Reference no: EM132967906

Problem -

Part a - MNO Ltd prepares accounts to 31 December each year. On 1 January 2016, the company acquired the right of using the asset by means of a finance lease. Details of lease agreement are as follows:

Cash price of the asset: $27,500

Lease term: 5 years

Payments due annually in advance (i.e. at beginning of year): $6595

Useful life of asset: 8 years

Rate of interest implicit in lease: 10% per annum

MNO will obtain the legal ownership of asset at the end of lease term. The company calculates depreciation (regarding the right of use asset) on the straight line basis.

Required -

1. Calculate the finance charge and depreciation charge for each of the year to 31 December 2016, 2017, 2018.

2. Calculate the lease liability (split of non-current and current liability is required) at the end of each financial year 31 December 2016, 2017 and 2018.

(Hint: amortization table is suggested to use for calculation, financial statements extract are not required)

Part b - On January 1, 2020, PQR Ltd entered into a two year lease for a truck. The contract contains an option to extend the lease term for a further one year. PQR Ltd believes that it is reasonably certain to exercise this option. The trucks have a useful economic life of ten years.

Lease payments are $10,000 per year for the initial term and $15,000 per year for the option period. All payments are due at the end of each year. To obtain the lease, PQR Ltd incurs initial direct costs of $5,000. PQR Ltd's incremental rate of borrowing is 7%.

Required - Calculate the initial carrying amount of the lease liability and the right of use asset and provide the double entries needed to record these amounts in PQR Ltd's financial records.

Part c - State the main criteria to determine leasing arrangement as finance lease.