On 1 July 2017, Orion Ltd leases a machine with a fair value of $69 594 to Triton Ltd for 5 years at an annual lease payment of $16 000. The lease is cancellable, but a penalty equal to 50% of the total lease payments is payable on cancellation. Triton Ltd does not intend to buy the machine at the end of the lease term. Orion Ltd incurred $2 000 to negotiate and execute the lease agreement. Orion Ltd purchased the machine for $69 594 just before the inception of the lease.

Extra information: (Orion purchased the machine from Triton Ltd. Carrying amount for Triton was $65,000.)

The Lease agreement details are as follows:

Length of lease 5 years

Commencement date 1-Jul-17

Annual lease payment, payable 30 June each year $16 000

Fair value of the machine at 1 July 2016 $69 594

Estimated economic life of the machine 8 years

Estimated residual value of the plant at the end of its economic life $4 000

Residual value at the end of the lease term, of which 50% is guaranteed by Triton Ltd $14 400

Interest rate implicit in the lease 9%

Requirement:

1): Does the Orion Ltd lease arrangement involve a finance lease or an operating lease?

Justify your choice.

2): Critically evaluate the accounting treatment adopted by Triton Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of AASB 117.

Extra guide: Comment on the advantage for Triton Ltd in selling and leasing back the machinery. (Note the question refers to Triton, not Orion as previously printed in error.)