PART A: The following scenario relates to questions 1 to 3. Atom Construction Ltd (Atom) manufactures, sells and leases heavy construction equipment. RATS Tech Ltd (RT), a regular customer, leased equipment on 1 April 2019, that had cost Atom $252,000 to manufacture. If RT were to purchase the equipment outright at inception date, the fair value would be $305,840 with economic life of seven years. The lease is non-cancellable by RT and RT has to pay initial payment of $63,160 (with lease component only) on 1 April 2019 and annual lease payments of $78,950 (with lease and non-lease components) beginning on 31 March 2020 until the last payment being made on 31 March 2023. Under the contract, RT has an option to purchase the equipment at the end of the lease term at $90,000. On 1 April 2019, the standalone price of the lease and non-lease components of an equivalent equipment are $72,000 and $18,000 respectively. Because of the heavy wear expected on construction equipment, the lease contains a guaranteed residual value clause wherein RT guarantees a residual value on 31 March 2023 of $65,000. At commencement date, RT expected that the residual value of the machine to be $20,000 at the end of the lease and Atom estimates that the residual value at the end of the lease term to be $80,000. At contract inception, both Atom and RT do not expect RT has a significant incentive to exercise the option to purchase the equipment at the end of the lease. Interest rate implicit in the lease as determined by Atom is 12% and the incremental borrowing rate used by RT is 15%. At 1 April 2020, Atom announces that it will no longer produce the leased equipment. RT concludes that it has a significant economic incentive to purchase the equipment because it will no longer be able to replace the equipment from Atom at the end of the lease term. The remaining payments are discounted using a revised incremental borrowing rate of 13%. On 1 April 2020, Atom entered into a sale and leaseback arrangement with Fair Deal Finance Ltd (FDF) of its servers. The servers were sold at $2,550,000 (above fair value by $300,000). The servers had a carrying amount of $1,515,000 which was removed from property, plant equipment of Atom. The profit of $1,035,000 was recognized as part of gains on rights transferred for the year. Eight annual lease payments of $376,800 are payable on 31 March each year commencing on 31 March 2021. The transfer of servers from Atom to FDF satisfies the requirements in HKFRS 15 Revenue from Contract with Customers' to be accounted for as a sale transaction. Incremental borrowing rate of this lease contract is determined by Atom as 8%. Relevant present value (PV) factors provided below as follows: PVF4,12% = 0.63552 PVF-OA,12 3.03735 PVF-OA8,4% = 5.74664 PVF3.13% = 0.69305 PVF-OA,13% 2.36116 PVF4.15% = 0.57175 PVF-OA,15% = 2.85498 Required: With reference to HKFRS 16 'Leases', assume all payments by cheque, answer the below parts using the PV factors provided, Q1: determine the lease classification of the equipment from the perspective of Atom. (5 marks) Q2: prepare journal entries of RT for the lease of the equipment for the years ended 31 March 2020 and 31 March 2021 respectively. (12 marks) Q3: explain the rationale for sale and leaseback with respect to Atom and prepare adjusting journal entries of Atom for the sale and leaseback of servers as at 1 April 2020. (8 marks)