Question

On 1 July 2018, Louis Ltd entered into an 8-year contract to lease a ship for its salvage business. When negotiating the lease contract, on 1 July 2018, Louis Ltd paid direct costs of $18,000 for engineering advice.

The lease contract requires Louis Ltd to make 8 annual lease payments of $80,000, with the first payment due on 30 June 2019. The lease contract includes a guaranteed residual of $130,000, which is payable by Louis Ltd at the end of the lease contract.

The ship is expected provide equal benefits each year of its expected useful life of 12 years, after which it will have a scrap value of $50,000.

The implicit interest rate in the lease contract is 7% per annum. The relevant present values are:

Interest Rate	Present Value of $1 in 8 years	Present Value of an annuity of $1 for 8 years
7%	0.5820	5.9713

Provide the journal entries for Louis Ltd relating to the lease contract for the financial year ending 30 June 2019, in accordance with AASB16 Leases. (5 marks)

Answer 1

Journal entries for louis ltd relating to lease contract for financial year ending on 30 june, 2019

1. Right to use Asset A/c Dr. $571,364(Note 1)

To Lease liability A/c $553,364(Note 2)

To cash/bank A/c $18,000(incremental direct cost)

(Being ROU asset recognised)

As per AASB 16, Lease, Louis should recognise an ROU asset equal to lease liablity plus any incremental direct cost(which would not have been incurred if lease contract was not persued). Also louis should depreciate the ROU asset over the lease term.

2. Depreciation on ROU asset A/c Dr. $71420.5

To ROU asset A/c $71420.5

(being depreciation charged for the year)

3. Interest expense A/c Dr. $38,735.48(Note 2)

Reduction in lease liability A/c Dr. $41,264.52(Note 2)

To Cash/bank A/c $80,000.00

(being first annual installment paid and segreggated in interest expense and lease liability)

Note:2.

As per AASB 16, Leases, Louis should recognise a lease liability at the present value of all the lease payments that includes annual payments in respect of lease and guaranteed residual value.

Lease liability = Annual lease payment * pvaf (7%,8 years) + guranteed residual value at end of the 8 year * pvf(7%, 8 year)

Lease liability= $80000*5.9713(given in question) + $130000*0.5820(given) = $553364

And at the every year end, out of the payment he made of $80000, he should book a interest expense at the implicit rate of contract and remaining should be treated as reduction in lease liability.

Interest Expense = Lease liability * rate of interest

Interest Expense = $553364*7% = $ 38735.48

Remaining Balance = $80000-$38735.48= $41264.52, it should be recognised as reduction in liability.