PART C: Leases

SP is considering to lease assets from three potential lessors. The assets are to be used in property development in next year. The Operation Manager provides the details as follows:

Potential lessor

Harman Bhd.

Armaq Bhd.

Mandel Bhd.

Type of asset

Excavator

Dump Truck

Concrete Mixer

Yearly rental

RM15,000 (first payment on 31 December 2018)

RM6,000 (first payment on 28 February 2019)

RM5,500 (first payment on 30 June 2019)

Inception date

1 January 2018

1 March 2018

1 July 2018

Lease term

10 years

7 years

3 years

Estimated economic life

25 years

15 years

7 years

Purchase option

RM75,000 at end of 10 years

None

None

Renewal option

None

None

None

Fair value at inception of lease

RM220,000

RM70,000

RM20,000

Guaranteed residual value

-0-

RM15,000

RM10,000

Estimated residual value at end of lease term

RM90,000

RM11,000

RM10,000

Implicit rate

5%

4%

4%

CASE INSTRUCTIONS:

(8)Assuming that SP agreed to lease all the assets, prepare journal entries at the inception date.

(9)For each of the assets, provide an analysis to determine the type of lease for lessor using the following schedule.

Criteria

Analysis

Transfer of title?

Yes/No

Contain purchase option?

Economic life test

PV of MLP equals at least substantially all of FV of the leased asset?

Type of lease

(10)Mr. Kiran proposes to issue bonds and with the cash proceeds purchase the needed assets. What might be the advantages of leasing the assets instead of owning them? What might be the disadvantages of leasing the assets instead of owning them?

(11)Mr Fairul, who just graduated in accounting, is auditing the company's financial statement for the year ended 31 December 2018. He noticed that on 1 December 2017, the company entered into a leasing contract as follows:

i.The non-cancellable term of 2 years.

ii.Rental of RM3,240 per year (paid on every 30 November). (The present value is RM5,778.)

iii.Estimated residual value after 2 years is RM1,100. SP guarantees the residual value of RM1,100.

iv.Estimated economic life of the asset is 5 years.

v.The implicit rate and SP's incremental borrowing rate is 8% per year.

In the company's accounting record, the company recorded the lease payment as rental expense. Mr Fairul asked Miss Farisha, an account clerk, why the company recorded as rental expense. Miss Farisha explained that, the lease contract does not meet the requirements to be classified as a finance lease as none of the test is met. Mr Fairul suspected that Miss Farisha referred to the old accounting standard.

Discuss the above situation. In your discussion be sure to include (a) what you determined about the lease, and (b) how you advised the company to account for this lease. Explain every journal entry that you believe necessary to record this lease properly including the correction for the error made.