QUESTION $1[15$ MARKS$]$

Omega is a listed entity and you are the financial manager. The financial statements of Omega for the

year ended $31$ March $2015$ are currently being prepared. One of Omega$$s directors has sent you three

questions regarding the financial statements. When I looked at the note which gave details of our

property, plant, and equipment, a separate component appeared for the first time this year. This

component was described as a right$-$of$-$use asset. Upon further investigation, I discovered that this

related to a warehouse which we started to lease on $1$ October $2014$ to provide us with more capacity.

The warehouse is being leased on a five$-$year lease contract at an annual rental of R$500,000,$ payable in

arrears. There is no option to extend the lease at the end of the five$-$year period. Based on current annual

interest rates $(10\%),$ these rentals have a total present value of R$1,895,000.$ We incurred direct costs of

R$105,000$ when arranging this lease with the owner.

The carrying amount of the right$-$of$-$use asset which is shown in the financial statements is R$1,8$ million. I

don$$t understand this at all. In particular, I have three questions about this that I would like you to answer:

Required

$1\mathrm{.}1$The warehouse would cost at least R$10$ million to purchase outright and has a useful life of around $25$

years. How can it be presented as Omega$$s asset in these circumstances?

$(3$ Marks$)$

$1\mathrm{.}2$ Where does the figure of R$1,8$ million come from? $(4$ Marks$)$

$1\mathrm{.}3$ Apart from the right$-$of$-$use asset, how else will this transaction affect our financial statements? I don$$t

need detailed workings here, just explanations.