Cuomo Mining Corporation, a public company whose stock trades on the Toronto Stock Exchange, uses IFRS. The Vice-President of Finance has asked you, the assistant controller, to prepare a comparison of the company’s current accounting of a lease with the contract-based approach, which is expected to be implemented in the near future. The lease you are going to use for this comparison was signed by Cuomo on April 1, 2011, with Bertrand Ltd. for a piece of excavation equipment. The following information relates to the agreement.
1. The term of the non-cancellable lease is three years, with a renewal option of one additional year at the annual rate of 125% of the initial payment. The equipment has an estimated economic life of 10 years.
2. The asset’s fair value at April 1, 2011, is approximately $1 million.
3. The asset will revert to Bertrand at the end of the initial term of the lease, or at the end of the renewal period should Cuomo exercise that option. The excavation equipment is expected to have a fair value of $600,000 on March 31, 2013, and $500,000 on March 31, 2014, which is not guaranteed.
4. Cuomo assumes direct responsibility for all executory costs for the excavation equipment.
5. The initial term of the lease agreement requires equal annual rental payments of $135,000 to Bertrand, beginning on April 1, 2011.
6. The lessee’s incremental borrowing rate is 9%. Bertrand’s implicit rate is 8% and is known to Cuomo.
7. Cuomo has a calendar year end. You have established that it has always been Cuomo’s intention to exercise the renewal period on account of the nature of the asset. Cuomo’s operations manager says that there is a 70% chance that the renewal period will be exercised.
Instructions
Answer the following, rounding all numbers to the nearest dollar.
Part 1
Using the current accounting under IFRS:
(a) Determine the accounting treatment of the lease agreement and obligation to Cuomo. What were the conditions that would need to be in place for the lease to be classified as a financing lease?
(b) Record all transactions concerning the lease for Cuomo for the fiscal year 2011.
Part 2
Using the proposed contract-based approach:
(c) Determine the amount of lease obligation at the signing of the lease.
(d) Use a computer spreadsheet to prepare an amortization schedule for Cuomo for the lease term including the expected lease renewal.
(e) Prepare all of Cuomo’s journal entries for fiscal years 2011 and 2012 to record the lease agreement and the lease pay-ments.
Part 3
Prepare a table of Cuomo’s balance sheet disclosure of all of the amounts that would appear concerning the right and the obligation at December 31, 2012. Follow with the statement of income disclosure for the fiscal year ending December 31, 2012. Be specific concerning classifications. Include a second column to show the amounts Cuomo reports for the same period following IFRS.