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Melodies and Riffs ltd. Is a company that manufactures premium electric guitars for music retailers. M&R recently entered into a lease agreement for manufacturing equipment.
Melodies and Riffs ltd. Is a company that manufactures premium electric guitars for music retailers. M&R recently entered into a lease agreement for manufacturing equipment. The lease agreement contains the following information:
- The lease term is for four years, with beginning of year payments starting May 1, 2021.
- At the inception of the lease, the equipment had fair market value of $350,000.
- Legal fees of $5000 were paid by M&R to its lawyers on May 1, 2021 for professional fees associated with setting up the lease.
- The lease is renewable for an additional two years at the option of the lessee. Annual payments for the first term are $64,000 and this includes $4000for the nonlease component of maintenance. Annual payment for the second term are $42,000 and this includes $2000 for the non-lease component of maintenance.
- Annual maintenance fees are paid on the same day as the lease payment and are recorded separately from the lease as a prepaid asset until later adjusted at yearend for the amount of benefits that have been used up
- The lease payments are close to market rate for the first term but for the second term, the rates are significantly lower than the market.
- At the end of the lease term, the asset will go back to the lessor. There is an unguaranteed residual value of $20,000 that the lessor hopes to recover. M&R has no obligation to pay any residual value deficiencies.
- Estimated useful life of the leased asset is 8 years. Economic life is also 8 years.
- The straightline depreciation method is used for the leased asset.
- M&R is a public company that uses IFRS and has a December 31 fiscal yearend
- M&Rs incremental borrowing rate is 10%. The implicit rate for the lessor is 8% and this is known by the lessee.
Required
- Prepare the journal entries for the first year of the lease (May 1, 2021 and including any entries on May 1, 2022).
- Prepare only the initial journal entry to records the ROU asset and lease liability on May 1, 2021 if there was now a bargain purchase option to purchase the asset at the end of the lease
- What amounts relating to the lease liability will appear on M&R December 31, 2021 Statement of Financial Position (current and long-term)?
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