MAA363 Corporate Accounting

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MAA363 Corporate Accounting

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MAA363 Corporate Accounting

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Course Code: MAA363
University: Deakin Business School

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Country: Australia

Question:

If the office equipment needs to be serviced or repaired, A Ltd is required to substitute an office equipment of the same type. Otherwise, and other than on default by B Ltd, A Ltd cannot retrieve the equipment during the six-year period. B intends to buy the office equipment from the lessor at the end of the lease term.
a)Determine whether a lease exists according to AASB16 Leases.
b)Describe four disadvantages of B Ltd for entering into this lease agreement.
c)Prepare a schedule of lease payments for B Ltd for the 6 years’ length of lease.
d)Prepare all journal entries to record the relevant transactions on in the records of B Ltd.
Discuss how your solution in Part A would differ if, instead of a guaranteed residual value, the contract contains a:
a)Bargain purchase option
b)Unguaranteed Residual
Explain the new single accounting model for lessees and the implications of this change on:
a)External users of financial reports
b)Statement of Financial Position (Balance Sheet)
c)Management contracts tied to key performance indicators such as return on assets
d)Debt covenants

Answer:

Determine whether a lease exists according to AASB16 Leases

The concept of a single lessee accounting model and requirements to recognize the assets and liabilities in the books of the lessee were introduced by the AASB 16, leases, issued by the Australian Accounting Standards Board.
In this case the contract, between A Ltd. and B Ltd., conveys the right to control the office equipment for a period of 6 years in exchange of periodic consideration, i.e. annual payment. Thus, there exist a lease in the contract between A Ltd and B Ltd.

Describe four disadvantages of B Ltd for entering into this lease agreement.

The four disadvantages of B Ltd. for entering into this lease agreement are mentioned below:

Instead of six years the lease period should have been for 8 years.
The annual lease rental is high due to the short period of lease term. Had the lease agreement been for 8 years the annual lease payment would have been lower.
The guaranteed residual value of the leased asset by the lessee is higher than the estimated residual value of the office equipment at the end of its economic life.
In case of default in annual lease payment A Ltd. can retrieve the equipment.   
Prepare a lease schedule (lessee) for the lease contract.

Date

Lease Payment

Interest expense

Principal reduction

Lease liability

30/06/2017

   8,000.00

   3,659.13

   4,340.87

   36,316.13

30/06/2018

   8,000.00

   3,268.45

   4,731.55

   31,584.58

30/06/2019

   8,000.00

   2,842.61

   5,157.39

   26,427.19

30/06/2020

   8,000.00

   2,378.45

   5,621.55

   20,805.64

30/06/2021

   8,000.00

   1,872.51

   6,127.49

   14,678.15

30/06/2022

   16,000.00

   1,321.85

   14,678.15

 –

Prepare all journal entries to record the relevant transactions on 1/7/2016, 30/6/2017 and 30/6/2022 in the records of B Ltd.

Date

Particulars

Dr ($)

Cr ($)

01/07/2016

Leased asset A/c

40657.00

 

 

A Ltd.

 

40657.00

 

(Being the office equipment taken on lease from A Ltd.)

 

 

30/06/2017

Finance charges A/c

3659.13

 

 

A Ltd.

 

3659.13

 

(Being the finance charges recorded)

 

 

30/06/2017

A Ltd.

8000.00

 

 

Insurance and maintenance expenses

2000.00

 

 

Bank

 

10000.00

 

(Being the lease payment made to A Ltd.)

 

 

30/06/2017

Depreciation

5442.83

 

 

Leased assets

 

5442.83

 

(Being the depreciation charged against leased asset under STM)

 

 

30/06/2017

Profit and loss Account

11101.96

 

 

Finance charges

 

3659.13

 

Insurance and maintenance expenses

 

2000.00

 

Depreciation

 

5442.83

 

(Being the expenses charged to profit and loss account)

 

 

30/06/2022

Finance charges A/c

1321.85

 

 

A Ltd.

 

1321.85

 

(Being the finance charges recorded)

 

 

 

A Ltd.

16000.00

 

 

Insurance and maintenance expenses

2000.00

 

 

Bank

 

18000.00

 

(Being the lease payment and guaranteed residual value paid to A Ltd.)

 

 

 

Depreciation

5442.83

 

 

Leased assets

 

5442.83

 

(Being the depreciation charged against leased asset under STM)

 

 

 

Profit and loss Account

8764.68

 

 

Finance charges

 

1321.85

 

Insurance and maintenance expenses

 

2000.00

 

Depreciation

 

5442.83

 

(Being the expenses charged to profit and loss account)

 

 

Discuss how your solution in Part A would differ if, instead of a guaranteed residual value, the contract contains a:

Bargain Purchase Option

If instead of guaranteed residual value the contract between A Ltd. and B Ltd. contains bargain purchase option then the lease shall be classified as capital or financing lease. In such case the lease must be disclosed in the Balance sheet of the lessee. Prevention of off balance sheet financing by the lessee it has been made mandatory to record the lease in the Balance sheet.  

Unguaranteed Residual

In case the contract between A Ltd. and B Ltd. instead of guaranteed residual value include unguaranteed residual value then lease will be considered as an operating lease and accordingly, the whole lease payment will be charged to profit and loss account as expense for the year in which the lease payment is accrued. The difference between operating lease and finance lease is the recognition of leased assets and liability in the Balance sheet. In case of finance lease the lessee must recognize the leased asset and liability in the Balance sheet in his books of accounts however, in case of operating lease there will be no such requirement to recognize the lease in Balance sheet. Also in case of operating lease the entire amount of lease is allowed to be charged to profit and loss account however, in case of finance lease on the finance charge is allowed to be set off against the revenue of the lessee in the profit and loss account. The lessee will be allowed to charge depreciation against the leased asset in case of finance lease. No such allowance is allowed in operating lease agreements.   
Explain the new single accounting model for lessees and the implications of this change:
What is the new single accounting model for lessee?
AASB 16 has introduced the concept of the new single accounting model which requires a lessee to recognize assets and liabilities in the books of accounts in respect of all lessees with a term in excess of 12 months.  
Implications on the following:
External users of financial reports
External users of financial reports will be able to assess the financial position and financial performance of an organization better. The single accounting model for lessee will ensure that the users of the financial reports will be aware of all leases which will have term periods in excess of 12 months. Thus, even in case of operating leases also as long as the lease is for a term in excess of 12 months the users of financial reports will be able to make out the presence of such lease with the appraisal of financial reports (Zadek et al., 2013).
Statement of Financial Position
The statement of financial position will be reflected better as the single lessee accounting system will ensure proper disclosure of leased assets and liabilities with all leases in excess of 12 months term period. Thus, the Balance sheet will reflect the true and fair financial position in terms of lease agreement with introduction of single lessee accounting system.
Management contracts tied to key performance indicators
Since the Balance sheet will recognize all leased assets and resultant liabilities for lease agreement with term periods in excess of 12 months management contracts tied to key performance indicators such as return on assets will also be influenced as the balance sheet will contain leased assets in addition to other assets which will be considered for calculating the return on assets. Thus, the quantum of return on assets will be affected due to the new single lessee accounting model (Bhasin, 2015).  
Debt covenants
The implications on debt covenants subsequent to the introduction of the new single accounting model for lessee in AASB 16, Leases, issued by the Australian Accounting Standards Board are as following:

The debt agreement shall be maintained properly as the lease agreement is also a formal debt.
Financing lease and operating lease will be recognized in financial statements will influence the debt covenants.  

Reference
Zadek, S., Evans, R., & Pruzan, P. (2013). Building corporate accountability: Emerging practice in social and ethical accounting and auditing. Routledge.
Bhasin, M. L. (2015). Corporate accounting fraud: A case study of Satyam Computers Limited.

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