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Tutorial 10

Financial Accounting 2
Accounting for Leases (Part 1)
Teaching Assistant Team

Problem 1
On February 21, 2015, Hooke Inc., purchased a machine for $1,200,000 for the purpose of
leasing it. The machine is expected to have a 10-year life, no residual value, and will be
depreciates on the straight-line basis. The machine was leased to Sage Company on March 1,
2015, for a 4-year period at a monthly rental of $15,600. There is no provision for the renewal
of the lease or purchase of the machine by the lessee at the expiration of the lease term. It is
known that Sage’s incremental borrowing rate is 7% per year.
Instructions:
a. What kind of lease is this? What expense should Sage Company record as a result of the
fact above for the year ended December 31, 2015?
b. Prepare the journal entries of the monthly rental payment for both lessor and lessee.
Prepare also the journal to depreciate the machine for the year ended December 31, 2015.
c. What income or loss before income taxes should Hooke record as a result of the fact above
for the year ended December 31, 2015?

Problem 2
Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build
three diesel-electric engines to Winston’s specifications. Upon completion of the engines,
Winston has agreed to lease them for a period of 10 years. The lease is noncancelable, becomes
effective on January 1, 2012, and requires annual rental payments of $413,971 each January 1,
starting January 1, 2012.
Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc.
and known to Winston is 8%. The total cost of building the three engines is $2,600,000, with
a fair value of $3,000,000 at the inception of lease. The economic life of the engines is
estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment
on a straight-line basis. At the end of the lease, Winston assumes title to the engines.
Instructions:
a. Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor
under IAS 17.
b. Prepare the journal entry(ies) to record the transaction on January 1, 2012, on the book of
Winston Industries.
c. Prepare the journal entry(ies) to record the transaction on January 1, 2012, on the book of
Ewing Inc.
d. Prepare the journal entries for both lessee and lessor to record interest expense (revenue)
at December 31, 2012 (prepare lease amortization schedule for 2 year).
e. Show the item and amounts that would be reported on the statement of financial position
at December 31, 2012, for both lessee and lessor.
f. If both uses IFRS 16 instead IAS 17, what would happen to their financial statement?