Reference no: EM133012122

On 1 July 2019, Dunbar Ltd entered into a five-year lease agreement with Reliable Finance Ltd for an item of machinery. Dunbar Ltd incurred initial direct costs of $1,350 to negotiate and arrange the lease. The lease agreement requires Dunbar Ltd to make five annual lease payments of $25,000 per year paid at the beginning of each year (in advance: annuity due) on 1 July with the first payment on 1 July 2019.

At the end of the lease term, Dunbar Ltd will return the item of machinery to Reliable Finance Ltd. The item of machinery will then be sold by Reliable Finance Ltd. The residual value of the item of machinery at the end of the lease term is determined by Reliable Finance Ltd to be $15,000 of which $10,000 has been guaranteed by Dunbar Ltd. At the commencement of the lease, Dunbar Ltd estimates that, at the end of the lease term, the item of machinery will realise $12,000 when it is sold.

The interest rate implicit in the lease is not determinable by Dunbar Ltd. Dunbar Ltd's incremental borrowing rate is 5% per annum which reflects the fixed rate at which Dunbar Ltd could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a four-year term, and with similar collateral.

Problem (a) Explain why, on 1 July 2019, the amount of the lease receivable recognised by Reliable Finance Ltd is different from the amount of the lease liability recognised by Dunbar Ltd.

Problem (b) Assume that, on 30 June 2021, Dunbar Ltd revises its estimate of the amount that the item of machinery is expected to realise when it is sold at the end of the lease term from $12,000 to $6,000. How would this revision affect the lease liability?