Question 3

Annabel Ltd leased a portable sound recording studio from Lessor Ltd. Lessor has no material initial direct cots. Annabel does not plan to acquire the portable studio at the end of the lease because it expects that, by then, it will need a larger studio. The terms of the lease are as follows:

Date of entering lease: 1 July 2019

Duration of lease: four years

Life of leased asset: five years

Lease payments: $50 000 at the beginning of each year

First lease payment: 1 July 2019

Lease expires: 1 July 2023

Interest rate implicit in the lease: 8 per cent

Guaranteed residual value expected to be paid: $40 000.

Required:

(a) Determine the fair value of the portable sound recording studio at 1 July 2019.

(b) Prepare a schedule for the lease payments from 1 July 2019 up to 1 July 2023.

(c) Prepare the journal entries to account for the lease in the books of Annabel Ltd at 1 July 2019, 30 June 2020, 1 July 2020 and 30 June 2021.

(d) At the termination of the lease, Annabel Ltd returns the portable sound recording studio to Lessor Ltd, but its fair value at that time is $25 000. What must Annabel Ltd do to comply with the terms of the lease? Prepare the journal entries in the books of Annabel Ltd for return of the asset to Lessor Ltd and the settlement of all obligations under the lease on 1 July 2023.