a On 30 June 2014, Baltimore Ltd enters into non-cancellable four-year lease agreement with Reliable Finance Ltd to lease an item of machinery. The machinery has an estimated useful life of four years. At the end of the lease term, Baltimore Ltd will return the item of machinery to Reliable Finance Ltd. The item of machinery will then be sold by Reliable Finance Ltd. The residual value of the machinery at the end of the lease term is $10,000 and this has been guaranteed by Baltimore Ltd. At the commencement of the lease, Baltimore Ltd estimates that, at the end of the lease term, the item of machinery will realise $12,000 when it is sold. The terms of the lease agreement require Baltimore Ltd to make four annual payments of $25,000 commencing on 30 June 2014. Baltimore Ltd's policy is to depreciate leased assets using the straight-line method. The interest rate implicit in the lease is 4%. Required (a) Determine the amounts at which Baltimore Ltd would recognize the right-of- use asset and the lease liability on 30 June 2014. (2 marks) (b) Prepare the journal entries to account for the lease by Baltimore Ltd between 30 June 2014 and 30 June 2017. (7 marks) (c) Explain the term 'executory costs'. What are three possible scenarios for their treatment in the lease agreement? (2 marks) (d) Explain the term 'initial direct costs' and how Baltimore Ltd would account for such costs. (2 marks) (e) What would happen if, when the machinery was returned to Reliable Finance Ltd at the end of the lease term, Reliable Finance Ltd immediately sold it for $6,000? Justify your answer. (2 marks) a On 30 June 2014, Baltimore Ltd enters into non-cancellable four-year lease agreement with Reliable Finance Ltd to lease an item of machinery. The machinery has an estimated useful life of four years. At the end of the lease term, Baltimore Ltd will return the item of machinery to Reliable Finance Ltd. The item of machinery will then be sold by Reliable Finance Ltd. The residual value of the machinery at the end of the lease term is $10,000 and this has been guaranteed by Baltimore Ltd. At the commencement of the lease, Baltimore Ltd estimates that, at the end of the lease term, the item of machinery will realise $12,000 when it is sold. The terms of the lease agreement require Baltimore Ltd to make four annual payments of $25,000 commencing on 30 June 2014. Baltimore Ltd's policy is to depreciate leased assets using the straight-line method. The interest rate implicit in the lease is 4%. Required (a) Determine the amounts at which Baltimore Ltd would recognize the right-of- use asset and the lease liability on 30 June 2014. (2 marks) (b) Prepare the journal entries to account for the lease by Baltimore Ltd between 30 June 2014 and 30 June 2017. (7 marks) (c) Explain the term 'executory costs'. What are three possible scenarios for their treatment in the lease agreement? (2 marks) (d) Explain the term 'initial direct costs' and how Baltimore Ltd would account for such costs. (2 marks) (e) What would happen if, when the machinery was returned to Reliable Finance Ltd at the end of the lease term, Reliable Finance Ltd immediately sold it for $6,000? Justify your answer. (2 marks)
