Question

Need to identify the financial reporting issue below:

On January 1, 2019, the company leased its administrative building under a contract wherein the company will obtain ownership of the building at the end of the 20-year lease for a nominal amount. Management decided to expense the lease payment of $3,000,000 for 2019 (paid on January 1, 2019). The building would have been capitalized at $30 million if treated as a capital lease. The building has a remaining economic life of 25 years. The interest for 2019 would have amounted to $2.45 million.

The depreciation expense was $2 million lower than CCA in 2019, not including any impact from transaction above. The tax rate enacted for 2020 and beyond was increased to 32%.

Company reports under IFRS

Income Statement

Sales $100,000,000

COGS ( $50,000)

Gross profit $50,000

Expenses:

Depreciation $6,000,000

Pension $2,000,000

Operating $28,000,000

Net Pretax Income $14,000,000

Income tax-estimate (30%) $4,200,000

Net income $9,800,000

Answer 1

The issue involved in the above question is whether lease payment should be capitalized or to be expensed to profit and loss Account.

From the above question it is clearly evident that the lease is a Financial lease ( capital lease) because the company has the option to buy it at the end of the lease tenure(20 years) and lease tenure covers the substantial economic life of the asset (20 years out of 25 ).

Under finance lease 1.liability has to be created for the future lease payments and asset has to be created for the acquisition of the asset.2.interest portion has to be recognized as a finance cost and depreciation shall also be claimed as the accounting standard.

Please have a look on the following journal entries. .

1.Lease asset...Dr . 30,000,000

To lease Liability.. 30,000,000

2. Finance expense ....Dr 2.45 million

To Lease liability . 2.45 million.

3. Depression a/c .....Dr 1,200,000

To Lease Asset . 1,200,000

4.Lease Liability a/c....Dr. 3,000,000

To Bank a/c 3,000,000

4.Depreciation a/c 1,200,000

Finance expense a/c 2,450,000

Profit and loss a/c 3,650,000