Intermediate Financial Accounting 2

Tutorial Week 10 – Lease Accounting (Part 1 – Basic)

Problem 1
On February 21, 2015, Hooke Inc., purchased a machine for $ 1,200,000 for the purpose of leasing it. The machine is
expected to have a 10-year life, no residual value, and will be depreciates on the straight line basis. The machine was
leased to Sage Company on March 1, 2015, for a 4-year period at a monthly rental of $15,600. There is no provision for the
renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. It is known that Sage’s
incremental borrowing rate is 7% per year.
Instruction:
a. What kind of lease is this? What expense should Sage Company record as a result of the fact above for the year ended
December 31, 2015?
b. Prepare the journal entries of the monthly rental payment for both lessor and lesse ! Prepare also the journal to
depreciate the machine for the year ended December 31, 2015.
c. What income or loss before income taxes should Hooke record as a result of the fact above for the year ended
December 31, 2015?

Problem 2
Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to
Winston’s specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years. The
lease is noncancelable, becomes effective on January 1, 2012, and requires annual rental payments of $413,971 each
January 1, starting January 1, 2012.

Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%.
The total cost of building the three engines is $2,600,000, with a fair value of $3,000,000 at the inception of lease. The
economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar
equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines.
Instruction :
a. Discuss the nature of this lease transection from the viewpoints of both lessee and lessor under IAS 17!
b. Prepare the journal entry or entries to record the transaction on January 1, 2012, on the book of Winston Industries
c. Prepare the journal entry or entries to record the transaction on January 1, 2012, on the book of Ewing Inc
d. Prepare the journal entries for both lessee and lessor to record interest expense (revenue) at December 31, 2012,
(prepare lease amortization schedule for 2 year)
e. Show the item and amounts that would be reported on the statement of financial position at December 31, 2012,
for both lessee and lessor
f. If both uses IFRS 16 instead IAS 17, what would happen to their financial statement?