Question

Question 4: (32 marks) Hopeful Ltd leased a portable sound recording studio from Lessor Ltd. Lessor has no material initial direct costs. Hopeful Ltd does not plan to acquire the portable studio at the end of the lease because it expects that, by then, it will need a larger studio. The terms of the lease are as follows: Date of entering lease: 1 July 2019. Duration of lease: four years. Life of leased asset: five years. Lease payments: $50,000 at the beginning of each year. First lease payment: 1 July 2019. Lease expires: 1 July 2023 Interest rate implicit in the lease: 8 per cent. Guaranteed residual: $40 000. Required: a) Determine the fair value of the portable sound recording studio at 1 July 2019 (7 marks) b) Prepare a schedule for the lease payments incorporating accrued interest expense. (15 marks) c) Prepare the journal entries to account for the lease in the books of Hopeful Ltd at 1 July 2019, 30 June 2020 and 1 July 2020 (5 marks) d) At the termination of the lease, Hopeful Ltd returns the portable sound recording studio to Lessor Ltd, but its fair value at that time is $25 000. What must Hopeful Ltd do to comply with the terms of the lease? Prepare the journal entries in the books of Hopeful Ltd for return of the asset to Lessor Ltd and the settlement of all obligations under the lease on 1 July 2023. (5 marks)

Answer 1

ANSWER:

a)

PV of MLP:-

PV of periodic rental payments = Annual rental payment * PVIFA (n=4, i = 8%)

= $ 50,000 * 3.5771

= $ 178,855

PV of guaranteed residual   = Guaranteed Residual * PVIFA (n=4, i = 8%)

= $ 40,000 * 0.7350

= $ 29,400

Lease Liability = PV of periodic rental payments + PV of guaranteed residual

= $ 178,855 + $ 29,400

= $ 208,255

b)

Lease Amortization Schedule
Date	Lease Payament	Interest Expense	Reduction in Liability	Lease Liability
1/7/2019				208,255
1/7/2019	50,000		50,000	158,255
1/7/2020	50,000	12,660	37,340	120,915
1/7/2021	50,000	9,673	40,327	80,589
1/7/2022	50,000	6,447	43,553	37,036
1/7/2023	40,000	2,963	37,036

Lease Payment on 1/7/2023 is the guaranteed residual.

c)

Date	Account Title	Debit ($)	Credit ($)
jul,1,2019	Leases Studio A/c Dr	208,255
To Lease Liability A/c		208,255
Leased Studio A/c Dr	50,000
To Cash A/c		50,000
Jun,30,2020	Interest Expense A/c Dr	12,660
To Interest Payable A/c		12,660
(Ref: Amortization Table)
Depreciation Expense - Leased Studio A/c Dr	42,064
To Accumulated Dep - Leased Studio A/c		42,064
( 208,255 - 40,000 ) / 4 years
jul,1,2020	Lease Liability A/c Dr	37,340
Interest Payable A/c Dr	12,660
To Cash A/c		50,000
(Balancing Figure 50,000 - 12,660 = 37,340)

d)

Date	Account Title	Debit ($)	Credit ($)
jul,1,2023	Accumulated Dep - Leased Studio A/c Dr	168,255
To Lease Studio A/c		168,255
(208,255 -40,000)
Leased Liability A/c Dr	37,036
Interest Payable A/c Dr	2,964
To Lease Studio A/c		40,000
Loss on Gauranteed Residual A/c Dr	25,000
To Cash A/c		25,000