Question One

On 1 st January 2017, Somerset Plc., a manufacturing company, leased a packaging equipment from Prowler Engineers, a company that specialises in making customized industrial machinery. The terms of the lease agreement provided the following:

Somerset Plc. was to pay annual lease rentals of 200,000 at the beginning of every year under the lease period The implicit interest was 10% p.a.

A residual value of 40,000 was guaranteed

The lease period was for 5 years which was equivalent to the economic life of the packaging equipment

Depreciation was to be computed using the reducing balance method, at the rate of 20% p.a

Interest over the lease period was to be spread using the sum-of-digits method.

At the time of entering into the lease agreement, Somerset Plc. had established that the incremental borrowing rate would be 12% p.a.

Required

a. Prepare journal entries to record the transactions that occur in each of the 5 years of the lease agreement

b. Prepare extracts of the Statement of Profit or Loss and the Statement of Financial Position for each of the 5 years of the lease agreement.

(Hint: A lease liability amortisation schedule will greatly assist you in answering part 'a'