- 11 Marks
Question
Ijaw Oil Plc has entered into agreement to lease a plant and equipment from Ogoni Leasing Company Limited. The lease period of the plant and equipment is six (6) years. The agreement provides that Ogoni Leasing Company Limited will incur upkeep expenses. The cost of the plant and equipment is N900,000,000,000. The economic useful life is 20 years. Ijaw Oil Plc is to pay annual lease rentals of N150,000,000 in advance over 6 years after which the plant and equipment revert to the lessor. The implicit interest rate is 22% per annum which is stated below:
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|---|
| PV(N1) | 1.0000 | 0.8197 | 0.6719 | 0.5507 | 0.4514 | 0.3700 | 0.3033 |
You are required to:
i. Calculate the present value of the lease rental of the equipment. (4 Marks)
ii. Identify with justification the kind of lease involved (3 Marks)
iii. Advise on how to treat the lease rentals paid by Ijaw Oil Plc. in the financial statements (1 Mark)
Answer
i. NET PRESENT VALUE
| Year | Cashflow N000 | Discount favor @22% | Present Value N000 |
|---|---|---|---|
| 0 | (150,000) | 1 | (150,000) |
| 1 | (150,000) | 0.8197 | (122,955) |
| 2 | (150,000) | 0.6719 | (100,785) |
| 3 | (150,000) | 0.5507 | (82,605) |
| 4 | (150,000) | 0.4514 | (67,710) |
| 5 | (150,000) | 0.3700 | (55,500) |
| Net Present Value | (579,555) |
OR
| Year | Cashflow N000 | Discount favor @22% | Present Value N000 |
|---|---|---|---|
| 0 – 5 | (150,000) | 3.8637 | (579,555) |
ii. This is an operating lease because of the following reasons:
- Under the lease arrangement, Ogoni leasing Company Ltd, the lessor, will bear the upkeep (maintenance) expenses on the plant and equipment Ijaw oil Plc will lease the plant and equipment for six years which is not a substantial part of the asset life of 20 years.
- Under the lease arrangement, the present value of the lease rental of N579,555,000 is less than and not equal to the fair value of N900,000,000,000 of the plant and equipment.
- The asset can be leased out again after the expiration of the initial six years lease period.
iii. The lease rental paid by Ijaw Oil Plc shall be expensed in the income statement of Ijaw Oil Plc as operating expenses while the outstanding lease rentals will be reported as current liability in the statement of financial position.
- Tags: Lease Classification, Lease Payments, Lease Treatment, Lease Type, Present Value
- Level: Level 2
- Uploader: Kwame Aikins