Question 4

On 1 January 2020, Lessee Ltd entered into a two-years lease with Lessor Ltd for a equipment. The contract contains an option to extend the lease term for a further a year. Lessee Ltd ascertained that it is reasonably certain to exercise this option. The equipment has a useful economic life of 10 years.

Lease payments are $25,000 per year for the initial term and $45,000 per year for the period when the option is exercised. All payments are due at the end of the year (i.e. 31 December). To obtain the lease, Lessee Ltd incurs initial direct costs of $12,500 on 1 January 2020. The interest rate within the lease is not readily determinable. Lessee Ltd s incremental rate of borrowing is 5%. Assume the initial direct cost was paid by Lessee Ltd to third party rather than to Lessor Ltd.

Required: a. Calculate the initial carrying amount of the lease liability and the right-of-use asset

and prepare the relevant double entries on 1 January 2020. (8 marks)

b. Prepare extracts from the financial statements of Lessee Ltd in respect of the lease agreement for the year ended 31 December 2020. (10 marks)

Note: amortization table is required to show

c. Comment the accounting treatment of lease payment in lessees book if the lease term is less than 12 months (2 marks)