ASSIGNMENT NUMBER 6 - LEASES: DUE DATE (TBA)
QUESTION ONE (1)
Baba Plc is a leasing company that was incorporated 6 years ago. The company engaged in
various leasing arrangements in the year to 31 December 2019 for which it needs advice
on their treatment in its financial statements.
Arrangement One
On 1 April 2019, Baba Plc leased out an excavating machine to Maka Mine Plc for 4 years. The
machine had a fair value of K1,240,000 at that date. The lease rentals were agreed at
K200,000, K180,000, K160,000 and K52,000 in year 1, year 2, year 3 and year 4
respectively (Due 1 April each year, starting on 1 April 2019).
The machine was acquired by Baba Plc on 1 January 2019 at a cost of K1,200,000. It had
an economic useful life of 8 years on that date. Baba Plc depreciates excavating machines on
cost with nil scrap value. (11 marks)
Arrangement Two
On 1 October 2019 Baba Plc leased a building from Jaka Real Estates Limited. The lease
period was 10 years while the building had an economic useful life of 50 years on that date.
The lease has a fair value of K840,000 on 31 December 2019.
Annual lease rentals were agreed at K86,000 payable on 1 October of each year
starting on 1 October 2019. The lease agreement had an implicit annual interest rate of
12%. Baba Plc has a policy of revaluating all buildings every 31 December. (9 marks)
Required:
(a) Explain why the new standard IFRS 16 has been issued? (5 marks)
(b) Explain the Differences between New IFRS 16 and IAS 17 (5 marks)
(c) Explain identifying features of a lease, as per IFRS 16 (5 marks)
(d) Explain the accounting treatment of leases under IFRS 16’Leases’ in the financial
statements of both lessor and lessee. (5 marks)
(e) What discount rate should a lessee use to calculate the present value of future
lease payments? (5 marks)
(f) For sale and leaseback transactions, which standard should be consulted in order
to determine whether the transaction, in substance, constitutes a sale? (5 marks)
(g) Advise Baba Plc on how the two arrangements should be treated in their
financial statements for the year to 31 December 2019. (Your answer should
include relevant calculations). (30 marks)
[Total: 50 Marks]
QUESTION TWO (2)
Your assistant has a reasonable general accounting knowledge but is not familiar with the detailed
requirements of all relevant financial reporting standards. One issue and two transactions on
which he requires your advice are shown below:
Issue One
Accounting treatment for the sale and lease back as per IFRS 16 in the books of both seller-
lessee and buyer-lessor.
Transaction One
On 1 January 2019, BMK Plc sells an item of machinery to Tamwibusha plc for its fair value
of K6 million. The asset had a carrying amount of K2.4 million prior to the sale. This sale
represents the satisfaction of a performance obligation, in accordance with IFRS 15 Revenue
1
from Contracts with Customers. BMK enters into a contract with Tamwibusha for the right to
use the asset for the next five years. Annual payments of K1 million are due at the end of each
year. The interest rate implicit in the lease is 10%. The present value of the annual lease
payments is K3.8 million. The remaining useful economic life of the machine is much is 12
years.
Transaction Two
On 1 January 2019, ABC Plc sells an item of machinery to XYZ plc for K9 million. Its fair value
was K8.4 million. The asset had a carrying amount of K3.6 million prior to the sale. This sale
represents the satisfaction of performance obligation, in accordance with IFRS 15 Revenue from
Contracts with Customers. ABC enters into a contract with XYZ for the right to use the asset for
the next five years. Annual payments of K1.5 million are due at the end of each year. The
interest rate implicit in the lease is 10%. The present value of the annual lease payments is
K5.7 million.
Required:
(a) In line with IFRS 16, explain accounting treatment for the sale and lease back in the
books of both seller-lessee and buyer-lessor. 10 marks.
(b) Explain how the transaction one will be accounted for on 1 January 2019 by both BMK plc
and Tamwibusha plc. 8 marks.
(c) Explain how the transaction two will be accounted for on 1 January 2019 by both ABC and
XYZ. 7 marks.
[Total 25 marks]
QUESTION THREE (3)
Lindaboni PLC entered into a lease contract with another entity, Bonilinda Ltd, a property
investment company in which Lindaboni is renting a property from Bonilinda Ltd. The lease has
a primary duration of three (3) years commencing on 1st January 2017 but subject to an
extension for further two (2) years at Lindaboni’s option. Lindaboni management have
indicated that the lease is required till such a time when the entity constructs their own
building. It is unlikely that Lindaboni plc will construct their own building within the next nine
(9) years due to scarcity of development land in Ndola.
The lease requires Lindaboni plc to pay rentals of K2.4 million annually in arrears. A security
deposit of K0.6 million refundable at end of the lease was paid at inception of the lease.
Further, Lindaboni plc incurred legal costs in arranging the lease contract amounting to K0.1
million. Lindaboni is also required to pay a supplementary 10% of the agreed rent as a
charge for cleaning and maintenance of the premises. Lindaboni’s pre-tax incremental
borrowing rate is 10% and Lindaboni’s applicable income tax rate is 35%.
For income tax purposes, all lease rentals and other lease related costs are tax
deductible.
Required
(a) Advise the directors of Lindaboni on the accounting treatment of the above
transaction in accordance with applicable IFRSs. You must also include the
deferred tax implication as part of your advice. (25 marks)
BM************************************************************BM
I LOVE ACCOUNTING!!!
Be kind to everyone.
Lecturer: Boniface Musonda (0955/66/77-959410, [email protected]
