Question 2

You have recently been appointed as finance director to a manufacturing company, Norman plc. A change in company policy during the previous year has meant that Norman plc leases manufacturing equipment instead of buying it. However, some directors are not aware of the contents of international financial reporting standards on leases, and are considering treating all lease payments as expenses in the profit and loss account.

You are reviewing the draft financial statements with the accountant who provides the information regarding the following lease transaction:

Norman plc leased an item of equipment on 1 April 20X1 for a 5-year period. Annual rentals in advance were 60,000. The cash price (fair value) of the asset on 1 April 20X1 was 260,000. The companys depreciation policy for this type of plant is on the straight-line basis over the life of the lease. The interest rate implicit in the lease is 8 per cent per annum (the present value of an ordinary annuity of 1 per year for 4 years at 8 per cent interest is

3.31).

Answer ALL Questions:

1. Advise other directors whether this lease agreement represents a finance lease or an operating lease in accordance with international financial reporting standards (show fully your workings).

(3 marks)

2. Prepare the income statement and balance sheet extracts of Norman plc in relation to the transaction for the year ended 31 March 20X2 to 31 March 20X6, in accordance with IFRS 16.

(14 marks)

3. Explain the differences between a finance lease and an operating lease, and critically discuss the issues of current debate relating to the recognition and classification of leases in corporate financial statements.

(18 marks)