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Difference between a finance lease and an operating lease

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Reference no: EM132701151

Question - Accounting for leases

Kapiti Ltd runs a successful chain of fashion boutiques, but has been experiencing significant cash flow problems. The directors are examining a proposal made by an accounting consultant that all the shops currently owned by the company be sold and either leased back or the businesses moved to alternative leased shops. The directors are keen on the plan but are puzzled by the consultant's insistence that all lease agreements for the shops be 'operating' rather than 'finance' leases.

Meanwhile, Scarlett Ltd agreed to lease their 5 buildings to Kapiti Ltd.

The lease agreement details are as follows:

Length of lease 10 years

Commencement date 1 July 2020

Annual lease payment, payable 1 July each year commencing 1 July 2020 ($120000 x 5) $600,000

Estimated economic life of the building 10 years

Annual Interest rate implicit in the lease 10%

The Chairman of the Board directed the Company Accountant to submit a detailed report on the above project.

Required -

A. Explain the difference between a finance lease and an operating lease.

B. Explain, by reference to the requirements of AASB 117, why the consultant prefers operating to finance leases.

C. Show how to record the lease of the buildings in the books of the Kapiti in accordance with AASB 6 as at 30 June 2021.

Reference no: EM132701151

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