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Question - On 1 July 2017, Eric Ltd (the lessee) enters into a five-year lease of a machine with an option to extend the lease for another five years at usual market rates, which are expected to rise relative to current lease payments. The lessee incurs initial direct costs associated with the lease of $10,000. According to the contract, contracted payments will be $115,000 in the first five years, with the first payment being made at the commencement of the lease, and $135,000 per year if the option for the further five years is taken. Lease payments are made on 30 June each year (meaning there are four more lease payments following the initial payment). Included within all these payments is a $15,000 per year service arrangement, which requires the supplier to maintain the machine in good working order.
At the commencement of the lease, the lessee makes a judgement that it does not intend to exercise the option to lease the asset beyond the first five years. The rate of interest charged by the lessor is not readily determinable, but the lessee's incremental borrowing rate is 6% for similar transactions. The machine is expected to have an economic life of 10 years and the financial year end is 30 June.
Required - Provide the accounting journal entries for the above lease transaction in the books of Eric Ltd for the year ended 30 June 2018.
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