Ice Ltd, a company that manufactures sells and leases tractors
has entered into an agreement to lease a tractor to House
Ltd.
The tractor cost Ice Ltd $50,000 to make and has a fair value of $57,429
on 1 July 2013. House is having difficulties meeting its debt covenant obligations and the parties have agreed to refer to the lease as an operating lease in all documentation. The lease agreement details
are as follows:
Lease term 3 years
Commencement date 1 July 2013
Lease payments: At lease inception $15,000
Annual lease payments commencing 30 June 2014 $16,000
Fair value of the machinery at 1 July 2013 $57,429
Estimated economic life of the machinery 5years
Estimated residual value of the machinery at the end of its economic life
$1000
Residual value at the end of the lease term$8,000
Residual value guaranteed by House Ltd$4,000
Included in the annual lease payments is an amount of $2,000 payable to
Ice Ltdfor insurance andmaintenance of the machinery The lease is cancellable, but a penalty of 50% of the total lease payments is payable on cancellation
and House Ltd would need to enter into a new lease with Ice Ltd.
House Ltd does not intend to take ownership of the machinery at the end of the lease term. Ice Ltd had legal fees of $841 associated with preparing the lease agreement.
Required:
A.State how both companies should classify the lease. Give reasons for your answer.
B.Determine the interest rate implicit in the lease Show workings
C.For House Ltd, prepare a schedule of lease payments
and show the journal entries for the
years ended 30 June 2014 and 30 June 2016
D.For lce Ltd,prepare a schedule of lease payments
and show the journal entries for the year
ended 30 June 2014
E.Assume none of the residual value is guaranteed by House Ltd
and there were no legal fees associated with preparing the lease agreement. Classify the lease for both companies and justify your answer. Show journal entries for both companies for the year ended 30 June 2014.