Question

This question about leasing appeared in the May 2007 exam.

‘On 1 April 2005, company DX acquired plant and machinery with

a fair value of $900,000 on a finance lease. The lease was for five
years with the annual lease payments of $228,000 being paid in
advance on 1 April each year. The interest rate implicit in the lease
was 13.44%. The first payment was also made on 1 April 2005.’

Requirement

i. Calculate the finance charge in respect of the lease that will be

shown in the company’s income statement for the year ended
31 March 2007.
ii. Calculate the amount to be shown as a current liability and a
non-current liability in the company’s balance sheet at 31 March
2007.

Take a minute to highlight the key details in the scenario and the
requirement.

They are:

• you have a finance lease

• the lease has a five-year term
• the lease payments are made in advance, at the beginning of
each year
• interest should be charged to the income statement using the
actuarial method, as an interest rate of 13.44% has been given
• you need to calculate the finance charge and the current and
non-current liability for the second year of the lease.

Only once you have extracted this information should you then
attempt the question.

Answer outline
The best way to answer this question is to set up a working in the
form of a table.

The table should show:

 • the initial liability - here, the fair value of the asset
• the lease payments which decrease the outstanding liability
- here, they happen at the beginning of each year
• the finance charge for the year which increases the liability -
here, the interest accrues at a rate of 13.44% a year on the
outstanding liability.

Complete the table for the year asked for in the question (year
ended 31 March 2007), and complete one additional year in order
to get the breakdown between the current and non-current finance
lease liability.

Then see below:

Your table should look as follows:

Capital Lease Interest @ Capital

outstanding payment 13.44% outstanding
($000s) ($000s) ($000s) ($000s)
(900 – (900 – 228
y/e 31 228) x + 90) =
March 900 (228) 13.44% = 762
2006 90

(762 – (762 – 228

y/e 31 228) x + 72) =
March 762 (228) 13.44% = 606
2007 72
y/e 31
March 606 (228)
2008
Footnote: Figures rounded to nearest 1000.

The finance charge for the year ended 31 March 2007 is $72,000
and the current and non-current finance liabilities at 31 March
2007 are $228,000 and $378,000 ($606,000 - $228,000)
respectively.

Adopting a methodical approach to reading the question scenario

and requirement should put you in the best position to extract all
the key details you need to answer the question accurately. If you
then use a working similar to the table above you should be able to
calculate the required figures within the time available for the
question.

This question from the May 2007 exam presented you with the
scenario where the lease payments were being made in advance.
Had the scenario been given where payments were made in
arrears (that is, at the end of each year) then you should still adopt
the same approach but simply reverse the order of columns 3 and
4 in the table above. This is because the interest would accrue
throughout the year on the capital outstanding at the beginning of
the year and the lease payment would pay off this interest and also
a portion of capital.
In summary, there are two key aspects to understanding IAS 17:
firstly you need to understand the IASB Framework principles
which underpin the required accounting treatment and secondly
you need to adopt a methodical approach to questions and
practice them frequently.