Zanzibar Limited entered into a lease agreement on July 1 2016 to lease some highly customized hydraulic equipment to Kaizen Limited. The fair value of the equipment as at that date was $ 700,000. The terms of the lease agreement were:Lease term5 yearsEquipment economic life6 yearsAnnual rental payment, in arrears (commencing June 30th 2017)$160,000Equipment residual value$100,000Guaranteed residual value by Zanzibar$60,000Incremental borrowing rate8%Interest rate implicit in the lease6%Note: the lease is cancellable but only with Zanzibar’s permissionAt the end of the lease term, the equipment is to be returned to Zanzibar Limited. On July 1, 2016, Zanzibar incurred $12,000 in legal fees for setting up the lease. The annual rental payment includes $10, 000 to reimburse the lessor for maintenance fees incurred on behalf of the lessee.Requirements:a)Discuss the nature of the lease using the appropriate criteria. Justify your answer using calculations where applicableb)Prepare the lease schedule for the Kaizen Limited c)Prepare Kaizen’s journal entries for 2016 & 2017 d)If the lease agreement could be cancelled at any time without penalty.Would your answer in parts a & b change? If yes, explain how and why.
Zanzibar Limited entered into a lease agreement on July 1 2016 to lease some highly customized hydraulic equipment to Kaizen Limited. The fair value of the equipment as at that date was $ 700,000. The terms of the lease agreement were:
Lease term
5 years
Equipment economic life
6 years
Annual rental payment, in arrears (commencing June 30th 2017)
$160,000
Equipment residual value
$100,000
Guaranteed residual value by Zanzibar
$60,000
Incremental borrowing rate
8%
Interest rate implicit in the lease
6%
Note: the lease is cancellable but only with Zanzibar’s permission
At the end of the lease term, the equipment is to be returned to Zanzibar Limited. On July 1, 2016, Zanzibar incurred $12,000 in legal fees for setting up the lease. The annual rental payment includes $10, 000 to reimburse the lessor for maintenance fees incurred on behalf of the lessee.
Requirements:
a)
Discuss the nature of the lease using the appropriate criteria. Justify your answer using calculations where applicable
b)
Prepare the lease schedule for the Kaizen Limited
c)
Prepare Kaizen’s journal entries for 2016 & 2017
d)
If the lease agreement could be cancelled at any time without penalty.Would your answer in parts a & b change? If yes, explain how and why.
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