Reference no: EM133185254
Question - You were asked by your audit client Tarlac Corporation to audit its accounting for a lease transaction for one of its warehouses. The details of the lease agreement are as follows:
The agreement calls for an annual payment of P400,000 every January 1 starting 2021 (the inception date of the lease).
Tarlac Corporation paid the lessor additional P200,000 in lease bonus and paid for direct lease expenses amounting to P300,000.
The original lease term is five years. Tarlac Corporation however has an option of renewing the lease agreement for another five years at a reduced annual rental rate of P250,000 still payable every January 1.
The warehouse a useful life of 20 years. The estimated salvage value of the warehouse were at P1M at the end of 5 years, P600,000 at the end of 10 years and P200,000 at the end of its useful life.
The implicit lease rate is 12%.
Required -
1. Assuming that it is highly probable that Tarlac Corporation will exercise the renewal option, what is the correct interest expense on the lease liability for the year 2022?
2. Assuming that it is NOT highly probable that Tarlac Corporation will exercise the renewal option and instead GUARANTEES the residual value of the asset after 5 years, what is the correct initial cost of the right to use asset?
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