Question - On the 1 July 2015, ChiHerbal Ltd entered into a lease agreement with Darlington Ltd to lease a specialised machine for four years. The machine was used in filtering water. The lease was classified as a finance lease. Darlington Ltd incurred costs of $3 643 to draw up the lease contract.
The machine had a fair value of $210 000 at the inception of the lease. The machine was expected to have a residual value of $15 000 at the end of the lease term when it was returned to Darlington Ltd, at which time it was sold for $10 000. ChiHerbal agreed to pay 50% of any shortfall in the residual value.
Four annual payments would be made on the 1 July each year, each of which was $66 000 per annum. This amount included $6 000 that ChiHerbal Ltd was required to pay Darlington Ltd to cover the annual insurance and maintenance costs of the machine.
Darlington Ltd requires a return of 12% on the investment in the leased asset. Balance date for both companies is 30 June.
Required:
a) Show calculations to prove that the interest rate implicit in the lease is 12%.
b) Prepare the schedule of lease payment and the general journal entries in the books of ChiHerbal Ltd, i.e. the lessee, to account for the lease from the inception of the lease until the leased asset was returned to the lessor
c) Prepare the schedule of lease receipt and the general journal entries in the books of Darlington Ltd, i.e. the lessor, to account for the lease from the inception of the lease until the leased asset was returned to the lessor.