Reference no: EM132613628
Question - Garlic Ltd. is a private company accounting under ASPE, and has a December 31 financial yearend. Garlic Ltd. wishes to expand its business operations, but is currently suffering serious cash flow difficulties. In order to raise the necessary capital required, Garlic Ltd. enters into an agreement with Leaseco Ltd. on April 1, 2018 for the sale and immediate leaseback of its manufacturing equipment at its fair market value of $225,000. The relevant details are as follows.
Manufacturing equipment: Historical cost $300,000; Net book value $195,000.
Initial lease term: Three years, annual payments of $76,000 beginning April 1, 2018 including $8,000 of insurance costs.
Bargain renewal term: Two years, annual payments of $19,000 beginning April 1, 2021 including $3,000 of insurance costs.
Garlic Ltd.'s incremental borrowing rate is 8%.
The residual value of the equipment will be $6,000 at the end of the above lease, and is guaranteed by Garlic Ltd.
Garlic Ltd.'s depreciation policy: straight-line basis over lease term.
REQUIRED -
a) Assume that the above lease is a capital lease, on the basis that the present value of future lease payments exceeds 90% of the fair value of the leased asset at the beginning of the lease. Prepare Garlic Ltd.'s journal entries (with supporting calculations) in respect of the sale and leaseback of its manufacturing equipment for the year ending December 31, 2018.
b) For public companies accounting under IFRS, the lessee may elect not to capitalize a lease but rather to expense the lease payments as incurred. Indicate the two specific types of leases for which such an election may be made.
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