Accounting for lease interest

GoldenRetreiver

Hi can anyone help me please? Have a question Accounting for ye 30.09.02 says 01.10.00 company entered lease agreement to purchase plant cost 447,000 - residual value = nil after 5 years. Lease terms 100,000 pa in advance for 5 years, first payment 01.00.00, the interest charg for this year has not been accounted for. Implicit interest rate = 6%.
On the trial balance there is "obligation under finance sheet CR 268,000"
Please can anyone help me - what is the procedure and journals required for this?

peugeot

Hi,

There are 3 methods used to calculate the interest:

Level spread method;
Sum of digits method; and
Actuarial method.

I think given the information they want you to calculate the interest using the actuarial method which charges interest as follows:

.........Borrowed......Repaid......Capital due......6% int......Closing bal

09/01...447,000......(100,000).....347,000......20,820......367,820
09/02...367,820......(100,000).....267,820......16,069*......283,889
09/03...283,889......(100,000).....183,889......11,033......194,922
09/04...194,922......(100,000).......94,922.......5,078......100,000
09/05...100,000......(100,000)

*this is the interest charge to be credited.

You would then credit HP in the balance sheet (creditor) and debit interest payable in the income statement.

Then you need to work out the HP falling due within one year and then falling due after one year and put these amounts in the appropriate sections of the bal sheet.

If a lease is paid in advance (as in the case here) then the first payment is wholly capital, hence no interest charge in the last payment (see IAS 17 'Leases').

Hope that makes this clearer for you.

Kind regards
Steve

GoldenRetreiver

Oh thank you so much, I have spent about 3 hours this afternoon trying to get my head round it. When you put it in the table like that it makes more sense. Dont know if I will ever get a full grasp of this topic - just when I think I'm getting there something more comes along to trip me up!

peugeot

Don't worry, leases appear to be easy but can be difficult! A way to check the figures above is to say:

Amount borrowed................£447,000
Amount repayable...............(£500,000)
Diff = interest....................£ 53,000

Interest payable:

Yr 1 20,820
Yr 2 16,069
Yr 3 11,033
Yr 4 5,078
.......53,000

That's just a double check but if you have time in the exam it will reassure you.:thumbup1:

GoldenRetreiver

Steve

Many thanks - this will this evenings homework now!

Regards

Sally

peugeot

One last thing to bear in mind is with the LAST interest instalment (year 4 above). This takes into account rounding differences because the first payment of a lease paid IN ADVANCE is purely capital i.e. no interest.

So the interest in the penultimate payment may not necessarily equal Y% x the opening capital amount.

Just so you don't spend hours trying to get it to agree exactly. You'll know if it's wrong because it should never be significantly different than what it mathematically should be!

Best wishes
Steve