Reference no: EM132807054

James entered into a ten-year lease of a floor of a building, with an option to extend for a further three years, on 1 July 2011. Lease payment are $50, 000 per year in advance during the initial term and $55, 000 per year during the optional period, all payable at the beginning of each year. The interest rate implicit in the lease was not readily determinable at the commencement of the lease: James's incremental borrowing rate at that date was 5% per annum. At this date, the management of James determined that the company was not reasonably certain to exercise the extension option. On 30 June 2017, James acquired Maggie and determined that it required two floors in the same building suitable for the increased workforce of the combined companies as this will result in cost saving synergies. Maggie had been leasing space in another building however on its acquisition, Maggie exercised an option to terminate this lease. On the same date, James entered into an eight-year lease of another floor in the building it currently occupies. James's incremental borrowing rate at 30 June 2017 is 6% per annum.

Problem 1: Explain the accounting treatment of the original lease entered into by James.