Big Fan Ltd is a listed company in the renewable energy sector. The entity is the only

company in the country that specializes in manufacturing wind turbines for their

customers, namely private farms and the government. The wind turbines are

manufactured using specialized machines, and it usually takes approximately $12$

months to manufacture each wind turbine.

Big Fan Ltd embarked on manufacturing a wind turbine for a customer who ordered a

wind turbine for their farm. As soon as the order was received on $1$ March $2022,$ Big

Fan Ltd started sourcing the raw materials e$.$g$.$ steel and began manufacturing the

tower sections, blades, and nacelle $($the part of the wind turbine that houses all the

generating components$).$

In order to manufacture the inventory item $($wind turbine$),$ a new specialized machine,

Machine S$,$ was required, which Big Fan Ltd decided to lease from a third party. Details

of the lease agreement are as follows:

$$ Five $(5)$ lease installments are due annually at the end of February each year.

$$ The lease installments will increase by $10\%$ each year as per the table below:

Due date: Lease installment

$28$ February $2023100000$

$29$ February $2024110000$

$28$ February $2025121000$

$28$ February $2026133100$

$28$ February $2027146410$

$$ The implicit rate applicable to the lease is $9\%$ per annum.

$$ The machine has an unguaranteed residual value at the end of the lease term

of R$25000.$ The lessee is not expected to make a payment for this at the end

of the lease.

$$ The machine had a fair value of R$470000$ at the start of the lease term $(1$ March

$2022).$

$8$ HFAC$334-1-$July$-$Dec$2023-$SA$1-$SK$-$V$4-20102023$

$$ The machine was modified by the third party prior to the start of the lease to be

specifically suited for the manufacturing of wind turbines created by Big Fan

Ltd$.$

$$ At the end of the lease, ownership of the machine reverts to the lessor however

Big Fan Ltd has a right to continue with the lease for another three years for

R$50000$ per annum. The market$-$related rent for a similar specialized machine

would cost around R$115000$ per annum.

$$ The machine has an expected economic and useful life of $5$ years.

$$ The first installment was paid on $28$ February $2023$ as per the agreement.

Big Fan Ltd continuously used Machine S throughout the financial year to manufacture

the wind turbine and therefore, the machine was never left idle.

The accountant of Big Fan Ltd accounted for the lease in the current financial year as

follows, along with an explanation as to how it was calculated:

Date Journal Details Dr Cr Explanation

R R

$28$

February

$2023$

Lease expense $127102$ Expense calculated by

straight$-$lining the total of

the lease payments and the

unguaranteed residual

value over the lease term

i$.$e$.(100000+110000$

$+121000+133100+146$

$410+25000)/5=127102$

Bank $100000$

Lease liability $27102$

Accounting for the lease expense regarding

Machine S for the year

Additional information:

$$ Big Fan Ltd a $28$ February financial year end.

$$ Big Fan Ltd depreciates all machinery using a straight$-$line basis over its useful

life.

$$ SARS grants the same wear and tear allowance for Machine S i$.$e$.5$ years

$$ The lease payments are deductible for tax purposes when paid.

$$ The company tax rate is $28\%.$

$9$ HFAC$334-1-$July$-$Dec$2023-$SA$1-$SK$-$V$4-20102023$

REQUIRED:

$2\mathrm{.}1$ Calculate the lease liability regarding Machine S at the start of the lease i$.$e$.1$

March $2022.$ Round off your final answer to the nearest Rand. $(6$ marks$)$

$2\mathrm{.}2$ Briefly discuss how you would classify the lease $($i$.$e$.$ operating or finance lease$).$

You may make reference to your answer in $2\mathrm{.}1$ as part of your justification.

$(9$ marks$)$

$2\mathrm{.}3$ Review whether or not the accountant$$s treatment of the lease is correct in

terms of IFRS $16.$ Also, briefly discuss how it should be measured if you do not

agree with the accountant$$s treatment. No calculations are required as part of

your answer. $(15$ marks$)$

$2\mathrm{.}4$ Assume that the lease is a finance lease. Prepare extracts from the Statement

of Financial Position of Big Fan Ltd as at $28$ February $2023$ using only the

information given in the question. Notes to the financial statements are not

required. Round off answers to the nearest Rand. Ignore VAT. You may make

reference to your answer in $2\mathrm{.}1$ as part of this answer. $(10$ marks$)$

$2\mathrm{.}5$ Discuss, in terms of IAS$23$ Borrowing Costs, whether or not the lease finance

cost will be able to be capitalised to the cost of the inventory item $($wind turbine$).$

Provide reasons for your answer. No calculations are required.