(a) When accounting for finance leases, accountants prefer to overlook legal form in favour of commercial substance.

Required:

Discuss the above statement in the light of the requirements of IAS 17 Leases.

(b) State briefly how you would distinguish between a finance lease and an operating lease.

(c) Smarty plc finalises its accounts annually on 31 March. It depreciates its machinery at 20% per annum on cost and adopts the ‘Rule of 78’ for allocating finance charges among different accounting periods. On 1 August 20X7 it acquired machinery on a finance lease on the following agreement:

(i) a lease rent of £500 per month is payable for 36 months commencing from the date of acquisition;
(ii) cost of repairs and insurance are to be met by the lessee;
(iii) on completion of the primary period the lease may be extended for a further period of three years, at the lessee’s option, for a peppercorn rent.
The cash price of the machine is £15,000.
Required:
(1) Set out how all ledger accounts reflecting these transactions will appear in each of the four accounting periods 20X7/8, 20X8/9, 20X9/Y0 and 20Y0/Y1.
(2) Show the income statement entries for the year ended 31 March 20X8 and balance sheet extracts as at that date.