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