GREAT ZIMBABWE UNIVERSITY

MUNHU MUTAPA SCHOOL OF COMMERCE

DEPARTMENT OF ACCOUNTING N INFORMATION SYSTEMS

NAMES : ANGELA K MARAMBA M202952

LORRAINE M NDUDZO M202042

PROGRAMME: ACCOUNTING

CELL NUMBER : 0785644602 / 0777820212

MODULE: HACC 413 FINANCIAL REPORTING

LECTURER: MR TAGWIREYI

ASSIGNMENT QUESTION: LEASES QUESTION 2

QUESTION 2

a) The directors of Y Ltd have requested you to explain to them how leases are accounted for in
the hands of the Lessee by clarifying on;

i)Definition
A lease is an agreement whereby the lessor (legal owner) conveys to the lessee (user) in return
for a payment or series of payments the right to use an asset for an agreed period of time. In a
lease, the lessee obtains the right to use an asset legally owned by the lessor for a period of
time. The rights of a lessee are different from those of an owner of an asset or a party to a
service agreement that does not transfer a right of use. Nevertheless, a lessee does have
certain rights that receive accounting recognition as an asset because a lessee has control over
an economic resource and is benefiting from the use of the asset.

ii)Initial recognition and measurement

The right-of-use asset is measured at cost at the commencement date. The cost of Right of use
comprises (IFRS 16.24):

 the amount equal to the lease liability at its initial recognition,

 lease payments made at or before the commencement of the lease (less any lease
incentives received),
 any initial direct costs incurred by the lessee
 an estimate of costs to be incurred by the lessee in dismantling and removing the
underlying asset, restoring the site on which it is located or restoring the underlying
asset to the condition required by the terms and conditions of the lease, unless those
costs are incurred to produce inventories (recognised under IAS 37).

iii)Subsequent measurement
After initial recognition, a lessee measures the lease liability by:
 increasing the carrying amount to reflect interest on the lease liability;
 reducing the carrying amount to reflect the lease payments made
 remeasuring the carrying amount to reflect any reassessment (see 2.4.2) or lease
modifications (see Section 7.2); and revised in-substance fixed lease payments (see
2.4.2). IFRS 16.37
Interest on the lease liability in each period during the lease term is the amount that produces
a constant periodic rate of interest on the remaining balance of the lease liability. The ‘periodic
rate of interest’ is the discount rate used in the initial measurement of the lease liability
(see 2.2.3) or, if appropriate, the revised discount rate (see 2.4.2 and Section 7.2). IFRS
16.BC183 Lessees cannot choose to measure lease liabilities subsequently at fair value.
iv)Presentation
Lessee presentation IFRS 16.47–50 A lessee presents leases in its financial statements as
follows.

Statement of financial position

Right-of-use asset – Separate presentation in the statement of financial position* or disclosure
in the notes to the financial statements Lease liability – Separate presentation in the statement
of financial position or disclosure in the notes

Statement of profit or loss and other comprehensive income

Lease expenses – Separate presentation of interest expense on the lease liability from
depreciation of the right-of-use asset – Presentation of interest expense as a component of
finance costs

Statement of cash flows

Operating activities – Variable lease payments not included in the lease liability – Payments for
short term and low-value leases (subject to use of recognition exemption) Financing activities –
Cash payments for principal portion of lease liability Depending on ‘general’ allocation – Cash
payments for the interest portion are classified in accordance with other interest paid * Right-
of-use assets that meet the definition of investment property are presented within investment
property.

iv)Disclosure
Relating to the statement of financial positions
 Additions to right-of-use assets – Year-end carrying amount of right-of-use assets by
class of underlying asset and (if they are not presented separately) the corresponding
line items in the statement of financial position
 Lease liabilities and the corresponding line items in the statement of financial position if
lease liabilities are not presented separately
 Maturity analysis for lease liabilities IFRS 16.53–54 Relating to the statement of profit or
loss and other comprehensive income (including amounts capitalised as part of the cost
of another asset)
 Depreciation charge for right-of-use assets by class of underlying asset
 Interest expense on lease liabilities
 Expense relating to short-term leases for which the recognition exemption is applied
(leases with a lease term of up to one month can be excluded)
 Expense relating to leases of low-value items for which the recognition exemption is
applied
 Expense relating to variable lease payments not included in lease liabilities
 Income from sub-leasing right-of-use assets
 Gains or losses arising from sale-and-leaseback transactions IFRS 16.53 Relating to the
statement of cash flows
 Total cash outflow for leases IFRS 16.55 Other
  Amount of short-term lease commitments if current short-term lease expense is not
representative for the following year Qualitative disclosures IFRS 16.58, 60, 7.B11
 Description of how liquidity risk related to lease liabilities is managed
 Use of exemption for short-term and/or low-value item leases

On 1 January 2017 Mkanyi bought a small bottling and labelling machine from Dhakwaz Ltd
under a finance lease. The cash price for the machine is $77,100, while the amount to be paid
under the lease is $100,000. The agreement requires the immediate payment of a $20,000
deposit while the balance being settled in 4 equal instalments commencing 31 December 2017.
The charges of $22,900 represents interest of 15% per annum calculated on the remaining
liability during the period. Depreciation on the plant is provided for at the rate of 20 % per
annum straight line basis assuming a residual value of nil.
Required:
Present the journals and the financial statements extracts in respect of the information
available for Mkanyi for the year ended 31 December 2017. (10 marks)

SOLUTION

Amortization table

Mkanyi Limited

YEAR Opening Balance Repayment interest 15% capital amount Balance

1 77,100.00 20,000.00 57,100.00

2 57,100.00 20,000.00 8,565.00 11,435.00 45,665.00

3 45,665.00 20,000.00 6,849.75 13,150.25 32,514.75

4 32,514.75 20,000.00 4,877.21 15,122.79 17,391.96

5 17,391.96 20,000.00 2,608.79 17,391.21 0.76

Date JOURNALS DR $ CR $

1 January 2017 Leased Asset 77 100

Lease liability

Being entry to receive lease asset. 77 100

1 January 2017 Lease Obligation 20 0000

Cash

Being entry to record cash deposit. 20 000

31 December 2017 Depreciation 15420

Provision for depreciation

Being depreciation charged for the year. 15420

31 December 2017 Interest Expense 8565

Lease liability

Being entry to record interest charge for the year. 8565

31 December 2017 Instalment 20 000

Lease liability

Being entry to record instalment for the lease. 20 000

 Mkanyi

Statement of Profit and loss and other Comprehensive Income for the year 31 December 2017

Year 1 Year 2 Year 3 Year 4 Year 5

Interest Paid 8,565.00 6,849.75 4,877.21 2,608.79

Depreciation 15,420.00 15,420.00 15,420.00 15,420.00 15,420.00

Mkanyi

Statement of Financial Position as at 31 December 2017

Non Current Assets Year 1 Year 2 Year 3 Year 4 Year 5

Bottling And Labelling Machine 77,100.00 77,100.00 77,100.00 77,100.00 77,100.00

Acc. Depreciation 15,420.00 30,840.00 46,260.00 61,680.00 77,100.00

NBV 61,680.00 46,260.00 30,840.00 15,420.00 -

Non Current Liabilities

Lease liability 32,514.75 17,391.96 - -

Current Liabilities

Lease liability 13,150.25 15,122.79 17,391.96 -

45,665.00 32,514.75 17,391.96 -

C) Compare and contrast a Finance lease and an Operational lease (10 marks)
Solution
-Operating leases require lease expenses to be recognized on a straight-line basis over the
lease term, whereas finance leases (just like capital leases) require the lessee to recognize
interest expense and amortization expense, which means expenses will be higher at the
beginning of the lease and decrease over time.

A financial lease is a lease where the risk and the return get transferred to the lessee (the
business owners) as they decide to lease assets for their businesses. An operating lease, on the
other hand, is a lease where the risk and the return stay with the lessor.

The main difference between a finance lease and an operating lease are presented in the table
below

Financial Lease Operating Lease

A commercial contract
A commercial contract in which the
where the lessor allows the
lessor lets the lessee use an asset instead
1. Meaning lessee to use an asset in place
of periodical payments for the usually long
of periodical payments for a
period.
small period;

An operating lease is a
2. What it’s all about? A financial lease is a long-term concept.
short-term concept.

The ownership is transferred to the The ownership remains with

3. Transferability
lessee. the lessor.

It is a contract for a short

4. The term of the lease It is a contract for the long term.
term.

The contract is called a loan The contract is called the

5. Nature of contract
agreement/contract. rental agreement/contract.
 In the case of an operating
In the case of a financial lease, the
lease, the lessor would need
6. Maintenance lessee would need to take care of and
to take care of and maintain
maintain the asset.
the asset.

It lies on the part of the

7. Risk of obsolescence It lies on the part of the lessee.
lessor.

In the case of an operating

Usually, during the primary terms, it
lease, the cancellation can be
8. Cancellation can’t be done; but there can be
made during the introductory
exceptions.
period.

The expenses for the asset, such as Even the lease rent
9. Tax advantage depreciation and financing, are allowed deduction from the tax is
for a tax deduction to a lessee. allowed.

In a financial lease, the lessee gets an In an operating lease, the

10. Purchasing option option to purchase the asset he has taken lessee is not given any such
on a lease. option.