Question $2$

Accounting for Leases

Nelson Ltd $($NL$)$ entered into a lease agreement on $1$ January $2023$ to lease an equipment from

Kapiti Ltd $($KL$)$ on the following terms:

Duration of the lease $-7$ years

The useful life of the equipment $-10$ years

Bargain purchase price at the end of the lease of $$20,000.$ This price is expected to be

sufficiently lower than the fair value of the equipment at the end of the lease and it is

reasonably certain that NL will exercise the option.

Lease payments: $$20,000$ at the beginning of the lease on $1$ January $2023$ and at the end of

each year $$15,000(7$ payments starting on $31$ December $2023).$ The payments at the end of

each year include $$3,000$ reimbursement to the lessor for maintenance and insurance costs.

NL incurred $$5,000$ direct costs to set up the lease arrangement.

The interest rate implicit in the lease is $7\%.$ The economic benefits provided by the leased asset

are expected to be consumed evenly over its useful life.

The present value of an annuity of $$1$ for $7$ periods discounted at $7\%$ is $5\mathrm{.}3893$ and the present

value of an amount of $$1$ at the end of $7$ periods discounted at $7\%$ is $0\mathrm{.}6227.$

Required:

$($a$)$ In accordance with NZ IFRS $16,$ NL recognises a right of use asset and a lease liability. Explain

how the right of use asset and lease liability meet the definition of assets and liabilities, in

accordance with the $2018$ conceptual framework. $(7$ marks$)$

$($b$)$ What are the appropriate journal entries in the books of the lessee, NL: $(9$ marks$)$

at the inception of the lease, $1$ January $2023?$

at the end of the first year, $31$ December $2023?$

$($c$)$ What are the appropriate journal entries in the books of the lessor, KL: $(9$ marks$)$

at the inception of the lease, $1$ January $2023?$

at the end of the first year, $31$ December $2023?$