Finance lease- CFA website

CFA Level I FRA
#1

A company that prepares its financial statements according to IFRS leased a piece of equipment on 1 January 2020. Information relevant to the transaction is as follows:

  • Five annual lease payments of $25,000, with the first payment due 1 January 2020
  • Interest rate on similar company debt is currently 8%
  • The fair value of the equipment is $115,000
  • Useful life of the equipment is seven years
  • The company depreciates other equipment in the same asset class on a straight-line basis

The total expense related to the lease on the company’s 2020 income statement will be closest to:

  1. $25,000.
  2. $28,185.
  3. $22,024.

Solution

B is correct. Under IFRS 16 all leases are classified as a finance lease and must be capitalized.

Using a financial calculator for an annuity due at the beginning of the period:

PV of lease payments: PMT = $25,000, i = 8%, N = 5, Mode = Begin, Compute PV.

PV = $107,803

Therefore, the lease would be capitalized at $107,803.

Present value of the lease (asset value capitalized and initial liability) $107,803
Payment 1 January 2020 –25,000
Liability value 1 January 2020 $82,803
Interest expense in 2020 0.08 × $82,803 $6,624.25
Amortization expense for the year using the lease term as the useful life (no indication that the lease will be renewed beyond the initial term) $107,803/5 $21,560.63
Total expense in 2020 $28,184.88

My concern: 25,000 pmt includes 8,624.24 for interest, so liability in 2010= 107,803-8,624.24=99,178.76

where was i wrong?

#2

How do you figure that?

#3

By 107,803*8% :slightly_smiling_face:

#4

When is the first payment made?

#5

First year

#6

What’s the exact date?

#7

1/1

#8

So . . . how much time elapsed between the inception of the lease and the first payment?

#9

Understood :grinning:. Thank you

#10

My pleasure.

1 Like
#11

I’m confused that the interest is 62% of expected payments. I must be missing something.

Extracted from a financial statement:

Approximate future minimum lease payments under capital and all other leases = $1,305M.

Imputed interest = $813M.

Could someone please enlighten me? Thank you.

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#12

If the payment is at the start of the year there is no interest to pay on that 25,000
Interest = cost of borrowing over time.

Use the calcualtor
Once numbers in and computed under TVM
Press "nd PV = Amort
Set P1 = 1 P2 =2 scroll down
You will see your year 1 entries

#13

For the first payment, there’s no interest accrued yet because it’s made at the start of the lease. Interest is calculated on the remaining balance after that first payment. That’s why it’s only on the $82,803 balance, not the original $107,803. It’s one of those tricky parts of lease accounting!