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Classify the lease as a finance lease or operating lease

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Reference no: EM13492781

Question

Leases

On 1 July 2010, Otago Ltd leased a plastic-moulding machine from Nelson Ltd. The machine cost Nelson $130,000 to manufacture and had a fair value of $154,109 on 1 July 2010. The lease agreement contained the following provisions:

 

Lease term

4 years

Annual rental payment, in advance on 1 July each year

$41,500

Residual value at the end of the lease term

$15,000

Residual guaranteed by the lessee

Nil

Interest rate implicit in the lease

8%

The lease is cancellable only with the permission of the lessor.

 

 

The expected useful life of the machine is 6 years. Otago Ltd intends to return the machine to the lessor at the end of the lease term. Included in the annual rental payment is an amount of $1,500 to cover the costs of maintenance and insurance paid for by the lessor. The machinery is to be depreciated using the straight-line method.

Required:

a)         Classify the lease as a finance lease or operating lease, and justify your answer.

b)         Prepare the lease schedule for the lessee. Round all figures to the nearest dollar.

c)         Prepare the lease schedule for the lessor. Round all figures to the nearest dollar.

d)         Prepare all relevant journal entries for the Otago Ltd and Nelson Ltd for the year ended 30 June 2011. 

Note: Show all workings where necessary.

(Source: Picker, R., Leo, K., Alfredson, K., Radford, J., Pacter, P., & Wise, V. (2009). Australian accounting standards. (2nd edition) (p. 585). Brisbane: John Wiley & Sons.)

Reference no: EM13492781

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