Reference no: EM132558006

Mr Fairul, who just graduated in accounting, is auditing the company's financial statement for the year ended 31 December 2018. He noticed that on 1 December 2017, the company entered into a leasing contract as follows:

i. The non cancellable term of 2 years.

ii. Rental of RM3,240 per year (paid on every 30 November). (The present value is RM5,778.)

iii. Estimated residual value after 2 years is RM1,100. SP guarantees the residual value of RM1,100.

iv. Estimated economic life of the asset is 5 years.

v. The implicit rate and SP's incremental borrowing rate is 8% per year.

In the company's accounting record, the company recorded the lease payment as rental expense. Mr Fairul asked Miss Farisha, an account clerk, why the company recorded as rental expense. Miss Farisha explained that, the lease contract does not meet the requirements to be classified as a finance lease as none of the test is met. Mr Fairul suspected that Miss Farisha referred to the old accounting standard.

Discuss the above situation. In your discussion be sure to include

Question (a) what you determined about the lease, and

Question (b) how you advised the company to account for this lease. Explain every journal entry that you believe necessary to record this lease properly including the correction for the error made.