Accounting for leases

Kapiti Ltd runs a successful chain of fashion boutiques, but has been experiencing significant cash flow problems. The directors are examining a proposal made by an accounting consultant that all the shops currently owned by the company be sold and either leased back or the businesses moved to alternative leased shops. The directors are keen on the plan but are puzzled by the consultant's insistence that all lease agreements for the shops be 'operating' rather than 'finance' leases.

Meanwhile, Scarlett Ltd agreed to lease their 5 buildings to Kapiti Ltd.

The lease agreement details are as follows:

Length of lease 10 years Commencement date 1 July 2020 Annual lease payment, payable 1 July each year $600 000 commencing 1 July 2020 ($120000 x 5) Estimated economic life of the building 10 years Annual Interest rate implicit in the lease 10%