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Question:
  1. Explain how a 'finance' and 'operating' lease differ
  2. Explain management incentives to avoid classification as a finance lease
  3. Describe the lease issues covered in the Australian Interpretations
  4. Demonstrate how a lessee accounts for a finance lease
  5. Demonstrate how a lessee accounts for an operating lease
  6. Outline the note disclosures required of a lessee for finance and operating leases
  7. Demonstrate how a lessor that is a non-manufacturer or nondealer accounts for a finance lease
  8. Demonstrate how a lessor that is a manufacturer or dealer accounts for a finance lease
  9. Demonstrate how a lessor accounts for an operating lease
  10. Outline the note disclosures required of a lessor for leases
  11. Describe the accounting issue associated with a noncancellable operating lease
  12. Demonstrate how to account for a sale and leaseback transaction
  13. Summarise the proposed changes to lease accounting that are being considered by the standard setters
Answer:
Scenario 1:
Requirement a:

In the Books ChiHerbal Ltd.

Jornal Entries

 

 

 

Dr.

Cr.

Date

Particulars

Amount

Amount

15/10/2014

Bank A/c.

Dr.

$1,500,000

 

 

To,

Share Application A/c.

 

$1,500,000

 

(Being share application money received for 600000 shares)

 

 

 

Share Application A/c.

Dr.

$1,000,000

 

 

To,

Share Capital A/c.

 

$1,000,000

 

(Being application fund transferred to Share Capital A/c. for 500000 shares)

 

 

16/10/2014

Share Application A/c.

Dr.

$200,000

 

 

To,

Bank A/c.

 

$200,000

 

(Being excess share application money refunded)

 

 

30/10/2014

Share Issuance Cost A/c.

Dr.

$8,000

 

 

To,

Bank A/c.

 

$8,000

 

(Being cost of share issue paid)

 

 

15/11/2014

Share Allotment A/c.

Dr.

$1,000,000

 

 

To,

Share Capital A/c.

 

$1,000,000

 

(Being share allotment due)

 

 

15/11/2014

Bank A/c.

Dr.

$800,000

 

 

Share Application A/c.

Dr.

$200,000

 

 

To,

Share Allotment A/c.

 

$1,000,000

 

(Being due allotment money received and balance adjusted from the excess appliation fund)

 

 

1/12/2014

Share Final Call A/c.

Dr.

$500,000

 

 

To,

Share Capital A/c.

 

$500,000

 

(Being final call money due)

 

 

15/12/2014

Bank A/c.

Dr.

$380,000

 

 

Calls-in-Arear A/c.

Dr.

$20,000

 

 

Share Application A/c.

Dr.

$100,000

 

 

To,

Share Final Call A/c.

 

$500,000

 

(Being due final call money received, except 20000 shares, and balance adjusted from excess application fund)

 

 

22/12/2014

Share Capital A/c.

Dr.

$100,000

 

 

To,

Calls-in-Arear A/c.

 

$20,000

 

To,

Forfeited Share Liability A/c.

 

$80,000

 

(Being the 20000 shares forfeited accordingly)

 

 

 

Forfeited Share Liability A/c.

Dr.

$80,000

 

 

To,

Bank A/c.

 

$80,000

 

(Being the application and allotment money received from forfeited shares refunded)

 

 

Requirement b:

BALANCE SHEET

as on 30/06/2015

Particulars

Amount

Amount

Shareholders' Equity:

 

 

Authorised Equity Shares - 500,000 shares @ $5 per share

 

$2,500,000

Issued & Outstanding Equity Shares - 480,000 shares @ $5 per share

 

$2,400,000

Total Equity Capital

 

$2,400,000

Scenario 2:

In the books of ChiHerbal Ltd.

Journal Entries

 

 

 

Dr.

Cr.

Date

Particulars

Amount

Amount

31/12/2015

Depreciation Expenses A/c.

 

$26,000

 

 

 

Accumulated Depreciation- Machine A A/c.

 

$15,500

 

 

Accumulated Depreciation- Machine B A/c.

 

$10,500

 

(Being depreciation charged for 6 months on Machine A and Machine B)

 

 

 

Accumulated Depreciation- Machine A A/c.

 

$135,500

 

 

 

Machine A A/c.

 

$120,000

 

 

Gain on Revaluation A/C.

 

$15,500

 

(Being gain on revaluation recorded for Machine A)

 

 

 

Accumulated Depreciation- Machine B A/c.

 

$40,500

 

 

Loss on Devaluation A/c.

 

$4,500

 

 

 

Machine B A/c.

 

$45,000

 

(Being loss on devaluation recorded for Machine B)

 

 

 

Gain on Revaluation A/C.

 

$15,500

 

 

 

Asset Revaluation Reserve A/c.

 

$15,500

 

(Being gain on revaluation transferred to Assets Revaluation Reserve A/c.)

 

 

 

Asset Revaluation Reserve A/c.

 

$4,500

 

 

 

Loss on Devaluation A/c.

 

$4,500

 

(Being loss on devaluation transferred to Assets Revaluation Reserve A/c.)

 

 

30/06/2016

Depreciation Expenses A/c.

 

$32,333

 

 

 

Machine A A/c.

 

$15,833

 

 

Machine B A/c.

 

$16,500

 

(Being depreciation charged on Machine A and Machine B)

 

 

 

Loss on Devaluation A/c.

 

$3,167

 

 

 

Machine A A/c.

 

$1,167

 

 

Machine B A/c.

 

$2,000

 

(Being loss on devaluation of machine A & B recorded)

 

 

 

Asset Revaluation Reserve A/c.

 

$3,167

 

 

 

Loss on Devaluation A/c.

 

$3,167

 

(Being loss on devaluation transferred to Assets Revaluation Reserve A/c.)

 

 

Workings:

Computation of Accummulated Depreciation:

Particulars

 

Machine A

Machine B

Cost of Machine

A

$310,000

$210,000

Expected Life (in years)

B

10

10

Depreciation p.a.

C=A/B

$31,000

$21,000

Carrying Amount

D

$190,000

$180,000

Accumulated Depreciation

E=A-D

$120,000

$30,000

 

Depreciation Schedule for Machine A:

Date

Carrying Amount

Useful Life

Depreciation p.a.

Depreciation Period

Depreciation charged

Depreciated Value

Fair Value

Revaluation

 

A

B

C=A/B

D

E=CxD

F=A-C

G

H=G-F

31/12/2015

$190,000

10

$31,000

0.5

$15,500

$174,500

$190,000

$15,500

30/06/2016

$190,000

6

$31,667

0.5

$15,833

$174,167

$173,000

-$1,167

Depreciation Schedule for Machine B:

Date

Carrying Amount

Useful Life

Depreciation p.a.

Depreciation Period

Depreciation charged

Depreciated Value

Fair Value

Revaluation

 

A

B

C=A/B

D

E=CxD

F=A-C

G

H=G-F

31/12/2015

$180,000

10

$21,000

0.50

$10,500

$169,500

$165,000

-$4,500

30/06/2016

$165,000

5

$33,000

0.50

$16,500

$148,500

$146,500

-$2,000

Scenario 3:
Requirement a:

Proof of Implicit Rate:

Particulars

 

Amount

Annual Installment

A

$66,000

Less: Annual Insurance &Maintanence Cost

B

$6,000

Net Installment

C=A-B

$60,000

No. of Annual Installment

D

4

Required Rate of Return

E

12%

Present Value of Lease Liability

F

$182,241

PV of 1st Installment

G=[1/(1+E)^1]xC

$53,571

PV of 2nd Installment

H=[1/(1+E)^2]xC

$47,832

PV of 3rd Installment

I=[1/(1+E)^3]xC

$42,707

PV of 4th Installment

J=[1/(1+E)^4]xC

$38,131

Total PV of Installment

K=G+H+I+J

$182,241

Requirement b:

Schedule of Lease Payment:

 

 

 

 

 

 

Year

Lease Liability

Annual Repayment

Interest Rate

Interest Expense

Balance Liability

1

$182,240.96

$60,000.00

12.00%

$21,868.92

$144,109.88

2

$144,109.88

$60,000.00

12.00%

$17,293.19

$101,403.06

3

$101,403.06

$60,000.00

12.00%

$12,168.37

$53,571.43

4

$53,571.43

$60,000.00

12.00%

$6,428.57

$0.00

 

In the books of ChiHerbal Ltd.

Journal Entries

 

 

 

Dr.

Cr.

Date

Particulars

Amount

Amount

1/7/2015

Lease Assets A/c.

 

$210,000.00

 

 

 

Lease Liability A/c.

 

$210,000.00

 

(Being asset required from lease)

 

 

30/06/2016

Interest on Lease A/c.

 

$21,868.92

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

 

Interest Payable A/c.

 

$21,868.92

 

 

Accrued Expenses A/c.

 

$6,000.00

 

(Being annual interest on lease and insurance & maintenance charges due)

 

 

 

Depreciation on Leased Assets A/c.

 

$48,750.00

 

 

 

Accum. Depreciation A/c.

 

$48,750.00

 

(Being depreciation charged on leased asset)

 

 

1/7/2016

Interest Payable A/c.

 

$21,868.92

 

 

Accrued Expenses A/c.

 

$6,000.00

 

 

Lease Liability A/c.

 

$38,131.08

 

 

 

Cash A/c.

 

$66,000.00

 

(Being annual lease payment paid including interest on lease, insurance & maintenance charges and partly lease principal)

 

 

30/06/2017

Interest on Lease A/c.

 

$17,293.19

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

 

Interest Payable A/c.

 

$17,293.19

 

 

Accrued Expenses A/c.

 

$6,000.00

 

(Being annual interest on lease and insurance & maintenance charges due)

 

 

 

Depreciation on Leased Assets A/c.

 

$48,750.00

 

 

 

Accum. Depreciation A/c.

 

$48,750.00

 

(Being depreciation charged on leased asset)

 

 

1/7/2017

Interest Payable A/c.

 

$17,293.19

 

 

Accrued Expenses A/c.

 

$6,000.00

 

 

Lease Liability A/c.

 

$42,706.81

 

 

 

Cash A/c.

 

$66,000.00

 

(Being annual lease payment paid including interest on lease, insurance & maintenance charges and partly lease principal)

 

 

30/06/2018

Interest on Lease A/c.

 

$12,168.37

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

 

Interest Payable A/c.

 

$12,168.37

 

 

Accrued Expenses A/c.

 

$6,000.00

 

(Being annual interest on lease and insurance & maintenance charges due)

 

 

 

Depreciation on Leased Assets A/c.

 

$48,750.00

 

 

 

Accum. Depreciation A/c.

 

$48,750.00

 

(Being depreciation charged on leased asset)

 

 

1/7/2018

Interest Payable A/c.

 

$12,168.37

 

 

Accrued Expenses A/c.

 

$6,000.00

 

 

Lease Liability A/c.

 

$47,831.63

 

 

 

Cash A/c.

 

$66,000.00

 

(Being annual lease payment paid including interest on lease, insurance & maintenance charges and partly lease principal)

 

 

30/06/2019

Interest on Lease A/c.

 

$6,428.57

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

 

Interest Payable A/c.

 

$6,428.57

 

 

Accrued Expenses A/c.

 

$6,000.00

 

(Being annual interest on lease and insurance & maintenance charges due)

 

 

 

Depreciation on Leased Assets A/c.

 

$48,750.00

 

 

 

Accum. Depreciation A/c.

 

$48,750.00

 

(Being depreciation charged on leased asset)

 

 

1/7/2016

Interest Payable A/c.

 

$6,428.57

 

 

Accrued Expenses A/c.

 

$6,000.00

 

 

Lease Liability A/c.

 

$53,571.43

 

 

 

Cash A/c.

 

$66,000.00

 

(Being annual lease payment paid including interest on lease, insurance & maintenance charges and partly lease principal)

 

 

 

Lease Obligation A/c.

 

$2,500.00

 

 

 

Cash A/c.

 

$2,500.00

 

(Being lease obligation paid for the shortfall between the residual price and selling price)

 

 

Requirement c:

Schedule of Lease Receipt:

Year

Leased Assets

Annual Receipts

Interest Rate

Interest Income

Asset Balance

1

$182,240.96

$60,000.00

12.00%

$21,868.92

$144,109.88

2

$144,109.88

$60,000.00

12.00%

$17,293.19

$101,403.06

3

$101,403.06

$60,000.00

12.00%

$12,168.37

$53,571.43

4

$53,571.43

$60,000.00

12.00%

$6,428.57

$0.00

 

In the books of Darlington Ltd.

Journal Entries

 

 

 

Dr.

Cr.

Date

Particulars

Amount

Amount

1/7/2015

Lease Receivables A/c.

 

$210,000.00

 

 

 

Assets A/c.

 

$210,000.00

 

(Being asset given in lease)

 

 

 

Lease Expenses A/c.

 

$3,643.00

 

 

 

Cash A/c.

 

$3,643.00

 

(Being expenses paid for lease agreement)

 

 

30/06/2016

Interest Receivables A/c.

 

$21,868.92

 

 

Lease Receivables A/c.

 

$6,000.00

 

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

Interest Income A/c.

 

$21,868.92

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount due)

 

 

1/7/2016

Cash A/c.

 

$66,000.00

 

 

 

Interest Receivables A/c.

 

$21,868.92

 

 

Lease Receivables A/c.

 

$44,131.08

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount received)

 

 

30/06/2017

Interest Receivables A/c.

 

$17,293.19

 

 

Lease Receivables A/c.

 

$6,000.00

 

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

Interest Income A/c.

 

$17,293.19

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount due)

 

 

1/7/2017

Cash A/c.

 

$66,000.00

 

 

 

Interest Receivables A/c.

 

$17,293.19

 

 

Lease Receivables A/c.

 

$48,706.81

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount received)

 

 

30/06/2018

Interest Receivables A/c.

 

$12,168.37

 

 

Lease Receivables A/c.

 

$6,000.00

 

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

Interest Income A/c.

 

$12,168.37

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount due)

 

 

1/7/2018

Cash A/c.

 

$66,000.00

 

 

 

Interest Receivables A/c.

 

$12,168.37

 

 

Lease Receivables A/c.

 

$53,831.63

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount received)

 

 

30/06/2019

Interest Receivables A/c.

 

$6,428.57

 

 

Lease Receivables A/c.

 

$6,000.00

 

 

 

Insurance & Maintenance Charges A/c.

 

$6,000.00

 

 

Interest Income A/c.

 

$6,428.57

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount due)

 

 

1/7/2019

Cash A/c.

 

$66,000.00

 

 

 

Interest Receivables A/c.

 

$6,428.57

 

 

Lease Receivables A/c.

 

$59,571.43

 

(Being annual interest on lease, insurance & maintenance charges for the asset and the part principal amount received)

 

 

 

Cash A/c.

 

$2,500.00

 

 

 

Lease Obligation Ac.

 

$2,500.00

 

(Being the shortfall between the residual value and selling price of the asset received from lessee)

 

 

 

Cash A/c.

 

$10,000.00

 

 

Loss on Sale of Assets A/c.

 

$2,500.00

 

 

Lease Obligation A/c.

 

$2,500.00

 

 

 

Assets A/c.

 

$15,000.00

 

(Being the assets sold at loss)

 

 

Scenario 4:

According to the paragraph 54 of AASB 138, if the research & development activity does not ensure any future economic benefit, expenditure on such activities should be considered as expense rather than asset. The research activities of ChiHerbal in the year 2013 did not provide any specific chemical, which could be used for synthesizing the product. Hence, it should also be treated as expenses.

In the year 2014, the research & development activity had successfully identified the three chemicals, required for the main product. Hence, as the explanation, stated in the paragraph 57 of AASB 138, the activity can be included in development phase and the cost incurred for the activity should be treated as intangible asset. In 2015, the company had developed the formula of the final product from the selected three chemicals through further research. Hence, the cost, incurred for conducting the research, should be considered as the cost of internally generated intangible asset as per the paragraph 65 of AASB 138. Paragraph 57 of AASB 138 takes into account development phase of an internal project undertaken by organization. As per this paragraph, if the organization or entity is able to demonstrate the following six categories, then they can recognize the intangible assets generated from development of any internal project.

  • It should take into consideration the intention of organization to widespread the intangible assets whether they intend to sell it or use it for business purpose.
  • Availability of intangible assets for its sale and usage in business purpose by considering the technical feasibility. In this regard, technical feasibility relates to completing the intangible assets.
  • Another category is to consider the ability of organization to use or sell the intangible assets.
  • In order to complete the development phase of internal project or to make use or sell the intangible assets, it is required to consider availability of sufficient financial, technical and other resources.
  • During the development phase, it is required to consider organization’s ability to reliably measure the expenditures that is associated with intangible assets.
  • Last category should consider the generation of feasible future economic benefits by intangible assets. Considering other things involves demonstration of market by organization for output produced by intangible assets. This includes intangible assets usefulness or it can be used internally that is for internal projects or considering intangible assets itself.

The probable future economic benefits generated by intangible assets are identified by entity because research phase is less advanced that development phase.

The journal entries for the stated transactions are given below:

In the books of ChiHerbal Ltd.

Journal Entries

 

 

 

Dr.

Cr.

Date

Particulars

Amount

Amount

 

 

 

 

 

30/06/2014

Research & Development Expenses A/c.

 

$1,000,000

 

 

 

Cash A/c.

 

$1,000,000

 

(Being the expenses for research & development paid)

 

 

 

Profit & Loss A/c.

 

$1,000,000

 

 

 

Research & Development Expenses A/c.

 

$1,000,000

 

(Being research & development expenses transferred to P/L A/c.)

 

 

30/6/2015

Research & Development Expenses A/c.

 

$2,000,000

 

 

 

Cash A/c.

 

$2,000,000

 

(Being the expenses for research & development paid)

 

 

 

Patent A/c.

 

$2,000,000

 

 

 

Research & Development Expenses A/c.

 

$2,000,000

 

(Being patent devloped from the research & development internally)

 

 

30/06/2016

Research & Development Expenses A/c.

 

$3,000,000

 

 

 

Cash A/c.

 

$3,000,000

 

(Being the expenses for research & development paid)

 

 

 

Patent A/c.

 

$3,000,000

 

 

 

Research & Development Expenses A/c.

 

$3,000,000

 

(Being patent devloped from the research & development internally)

 

 

References:

Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia

Weil, R. L., Schipper, K., & Francis, J. (2013). Financial accounting: an introduction to concepts, methods and uses. Cengage Learning

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