Question 2
Lease
SAXCO Ltd entered into a contract with Bakery SA Ltd on 1 March 2020 whereby Bakery SA Ltd will lease a specialized oven to SAXCO Ltd. The contract meets the requirements of a lease in terms of IFRS 16, leases.
The term of the lease are as follows:
Lease term 4 years
Initial payment R144 000
Instalment payable monthly in arrears R20 000
Useful life of oven 6 Years
The lessee’s incremental borrowing rate on 1 march 2020: 8% per annum
The lessee incurred R4 800 legal fees for negotiating the lease. It is impractical for the lessee to calculate the costs incurred by the lessor and as a result cannot calculate the interest rate implicit in the lease.
Required
(a) Calculate the right of asset and the corresponding lease liability for SAXCO Ltd at initial recognition.
(b) Prepare the journal entries in the accounting records of SAXCO Ltd for the year ended 28 February 2021
(a)
To calculate the right of asset and the corresponding lease liability, we need to determine the present value of the lease payments.
1. Calculation of the right of use asset:
The right of use asset is calculated as the initial payment plus the present value of the lease payments over the lease term.
Initial payment: R144,000
Present value of lease payments:
Lease term: 4 years
Monthly instalment: R20,000
Discount rate: 8% (incremental borrowing rate)
Using the present value of an annuity formula:
PV = PMT × [1 - (1 + r)^-n] / r
PV = R20,000 × [1 - (1 + 0.08)^-48] / 0.08
PV = R20,000 × (1 - 0.305) / 0.08
PV = R20,000 × 0.695 / 0.08
PV = R173,750
Right of use asset = Initial payment + Present value of lease payments
Right of use asset = R144,000 + R173,750
Right of use asset = R317,750
2. Calculation of the lease liability:
The lease liability is calculated as the present value of the lease payments over the lease term.
Lease liability = Present value of lease payments
Lease liability = R173,750
(b)
Journal entries in the accounting records of SAXCO Ltd for the year ended 28 February 2021:
1. Initial recognition of the lease:
Right of use asset Dr R317,750
Lease liability Cr R173,750
Cash Cr R144,000
2. Annual lease payment:
Lease liability Dr R20,000
Interest expense Dr (lease liability × incremental borrowing rate)
Depreciation expense Dr (right of use asset / useful life)
Cash Cr R20,000
Note: The interest expense is calculated as the beginning lease liability multiplied by the incremental borrowing rate.
This journal entry should be recorded monthly for the lease payments made during the year.