E20-3 question and solution

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E20.3 (LO 4, 5, 6, 11) (Type of Lease, Lessee Entries with Purchase Option) The following facts are for a non-cancellable lease agreement between Hebert Corporation and Russell Corporation, a lessee: Inception date July 1, 2023 Annual lease payment due at the beginning of each year, starting July 1, 2023 $20,066.26 Bargain purchase option price at end of lease term reasonably certain to be exercised by Russell $4,500.00 Lease term 5 years Economic life of leased equipment 10 years Lessor’s cost $60,000 Fair value of asset at July 1, 2023 $88,000 Lessor’s implicit rate 9% Lessee’s incremental borrowing rate 9% The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties about costs that have not yet been incurred by the lessor. The lessee assumes responsibility for all executory costs . Both Russell and Hebert use IFRS. Instructions Answer the following, rounding all numbers to the nearest cent. a-Calculate the amount of the right-of-use asset and lease liability. Show calculations using any of the following methods: (1) factor tables, (2) a financial calculator, or (3) Excel functions. b-Discuss the nature of this lease to Russell, the lessee. c-Discuss the nature of this lease to Hebert, the lessor. d-Prepare a lease amortization schedule for the lease obligation using a spreadsheet for Russell for the five-year lease term. e-Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2023 and 2024. Russell’s annual accounting period ends on December 31, and Russell does not use reversing entries.

EXERCISE 20.3 a. Initial Measurement of Right-of-Use Asset and Lease Liability Contractual Rights and Obligations under Lease, July 1, 2023, using 1. tables $20,066.26Annual rental payment X 4.23972 PV of annuity due of 1 for n = 5, i = 9% $85,075.32 PV of periodic rental payments $ 4,500.00Bargain purchase option X .64993 PV of 1 for n= 5, i = 9% $ 2,924.69 PV of bargain purchase option $85,075.32PV of periodic rental payments + 2,924.69 PV of bargain purchase option $88,000.01 Net investment at inception of lease 2. Using a financial calculator: PV $ ? Yields $ 88,000.01 I 9% N 5 PMT $ (20,066.26) FV $ (4,500) Type 1

EXERCISE 20.3 (CONTINUED) (a) (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type) Result: $88,000.01 rounded b. The lease would be set up as a right-of-use asset and lease liability under IFRS as it would not qualify for a short-term or low-value exemption.

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EXERCISE 20.3 (CONTINUED) c. This is a finance lease for the lessor for the following reasons: 1. The lease agreement has a purchase option that is reasonably certain to be exercised and 2. The PV of the minimum lease payments ($88,000) is equal to the fair value of the leased equipment allowing the lessor to recover all of its investment and earn a return on its investment in the leased equipment. The lease is a manufacturer/dealer lease as it gives rise to a profit (fair value of the assets of $88,000 exceed the cost of $60,000 by $28,000). d. Russell Corporation (Lessee) Lease Amortization Schedule Date Annual Lease Payment Plus BPO Interest (9%) on Unpaid Liability Reduction of Lease Liability Balance Lease Liability 7/1/23 7/1/23 7/1/24 7/1/25 7/1/26 7/1/27 6/30/28 $ 20,066.26 20,066.26 20,066.26 20,066.26 20,066.26 4,500.00 $ 104,831.30 * $ 6,114.04 * * 4,858.34 * * 3,489.62 * * 1,997.73 * * 371.57 1 * $16,831.30 * $20,066.26 13,952.22 15,207.92 16,576.64 18,068.53 4,128.43 $88,000.00 $88,000.00 67,933.74 53,981.52 38,773.60 22,196.96 4,128.43 0 .00 1 Rounding error is $.01 cent. e. 7/1/23 Right-of-Use Asset .................................... 88,000.00 Lease Liability ................................ 67,933.74 Cash ................................................ 20,066.26 To record inception and payment of lease

EXERCISE 20.3 (CONTINUED) e. (continued) 12/31/23 Interest Expense 1 ..................................... 3,057.02 Lease Liability ................................ 3,057.02 1 ($6,114.04 X 6/12 = ( $3,057.02) To record interest Depreciation Expense 2 .............................. 4,400.00 Accumulated Depreciation —Right-of-Use Asset ................. 4,400.00 2 ($88,000.00 ÷ 10 = ( $8,800.00; $8,800.00 X 6/12 = $4,400) To record depreciation expense 7/1/24 Interest Expense 3 .................................... 3,057.02 Lease Liability 4 ......................................... 17,009.24 Cash ............................................... 20,066.26 3 ($6,114.04 – $3,057.02) 4 ($20,066.26 – $3,057.02) To record lease payment 12/31/24 Interest Expense 5 ..................................... 2,429.17 Lease Liability .............................. 2,429.17 5 ($4,858.34 X 6/12 = ( $2,429.17) To record interest 12/31/24 Depreciation Expense 6 ............................. 8,800.00 Accumulated Depreciation —Right-of-Use Asset .......... 8,800.00 6 ($88,000.00 ÷ 10 years = ( $8,800.00) To record depreciation expense (Note to instructor : Because a purchase option was reasonably certain to be exercised, the leased asset is depreciated over its economic life rather than over the lease term.) E