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Determine the initial measurement of right-of-use asset cost

Home, - Initial measurement of the lease liability

Question 1: ABC Ltd enters into a five-year lease agreement with Legal Ltd on 1 July 2023 for an item of machinery.

There is a bargain purchase option that ABC Ltd will be willing to exercise at the end of the fifth year for $90 000. The machinery is expected to have a useful life of five years

There are to be five annual payments of $140 000, the first being made on 30 June 2024. Included within these payments is $20 000 representing payment to the lessor for insurance and maintenance of the equipment.

Additional information
Implicit interest rate: 8 per cent
Present value of an annuity in arrears of $1 for five years at 8 per cent = 3.9927
Present value of $1 in five years at 8 per cent = 0.6806

Required:

a) Determine the initial measurement of the lease liability

ANSWER a):

Periodic lease payments $120,000* 3.9927                479124

 

Bargain purchase option $90,000*0.6806                  61254

Lease liability at the initial measurement                   540378

b) Determine the initial measurement of right-of-use asset cost

ANSWER b):

Periodic lease payments $120,000* 3.9927                479124

Bargain purchase option $90,000*0.6806                  61254

Right of use asset                                     540378

c) Provide the accounting journal entries for the year ended 30 June 2024.

ANSWER c):

Date

Particulars

 Debit

 Credit

01-Jul-23

ROU assets Dr

       5,40,378

 

 

Lease Liability Cr

 

       5,40,378

 

(To record ROU assets)

 

 

 

 

 

 

30-Jun-24

Interest expenses Dr.

           43,230

 

 

Insurance and maintenance expenses Dr.

           20,000

 

 

Lease liability

           76,770

 

 

Cash

 

       1,40,000

 

(To record payment of 1st installment) (540378 * 8%= 43220)

 

 

 

 

 

 

30-Jun-24

Depreciation - ROU assets

       1,08,076

 

 

Accumulated depreciation

 

       1,08,076

 

(To record depreciation) (540378/5 years)

 

 

Question 2: Discuss when a company in the extractive industries needs to start accounting for its restoration costs? Explain the measurement requirement for potential restoration provisions.

ANSWER:
The restoration cost should be recognized by the entities throughout various phases of operations. If there is any activity which needs the restoration costs to be incurred in subsequent years then it should be recognized in the year of capitalization of assets rather than in actual period of incurrence. The provision is mainly measured as per AASB 137 and AASB 6. As per AASB 137, the provision should be best estimate of expenditure required to be settled at future date and if the time value of money is material then the amount should be recognized by discounting the future value of cash flows with appropriate discount rate. The discount rate to be considered for the provision will be the pre tax rate that affect the current market assessment of time value of money. Further, at the time of construction of facilities when there is obligation to remove the facilities after certain period then such cost will be capitalized to the cost of assets at the time of capitalization of assets itself considering appropriate discount rate. Further, such restoration cost capitalized would be amortized over the useful life of assets. If any restoration cost is incurring during ongoing operations then such costs should be recorded in respective phase of operation and should form part of cost of inventory. The entity should reassess the cost on periodic basis and accordingly should consider the impact. The cost of clean up and other misc expenses should be recorded in income statement only.

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