$4$

Problem $3(12$ Marks$)$

On January $1,2023,$ Shrek Inc. enters into a seven$-$year non$-$cancellable lease with

Fiona Ltd$.$ for machinery having an estimated useful life of nine years and a fair value of

$$4,300,000.$ Shrek$$s incremental borrowing rate is $8\%$ and Fiona$$s implicit rate is $6\%.$

Shrek uses the straight$-$line depreciation method to depreciate assets. Shrek will make

annual lease payments on January $1$ of each year. The lease includes a guarantee by

Shrek Inc. that Fiona Ltd$.$ will realize $$100,000$ from selling the asset at the expiration of

the lease, which Shrek expects to pay. Both companies adhere to IFRS.

Instructions

a$)$ Calculate the lease payment Fiona Ltd$.$ will charge Shrek $($assuming no

mark$-$up of the machinery from fair value$).$ Round to the nearest dollar.

b$)$ Calculate the present value of the lease payments. Round to the nearest

dollar.

c$)$ What kind of lease is this to Shrek Inc.? Why?

d$)$ Present the journal entries that Shrek Inc. would record during the first year

of the lease. Round to the nearest dollar