Question 5 (a)
Finance lease: annual lease payment and unearned finance income
8 marks
- Time to write
- About 16 minutes
- Topic
- Leases and AS 19
- Notes
- Crux notes
Question
Question 5 (a) · 8 marksZenith Ltd. has leased equipment that costs 8,96,76,240 over its useful life, for a three year lease period. The asset would revert to the Lessor after the lease term. You are informed that:
The guaranteed residual value and the estimated unguaranteed residual value is Rs. 1.2 lakh each.
The yearly lease payments have been so structured that the total of their present values, together with that of the asset's residual value, will equal its cost.
The implicit interest rate is 10%.
Ascertain the annual lease payment, and also the unearned finance income. The P.V. factor @ 10% for years 1 to 3 are, respectively, 0.909, 0.826 and 0.751.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- (i)–(iii)3 items, each marked on its own: give each its share.
- estimatedFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
- "Has leased equipment" is read with Zenith Ltd. as the lessor: the asset reverts to it, and unearned finance income is a lessor's figure.
- The lease runs over the equipment's useful life, so the lease term equals the useful life.
- "The residual value of the asset" is the guaranteed and the unguaranteed residual value together, ₹1.2 lakh each.
- The present-value factors are used as printed.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Annual payment derived from cost and the residual values 3 marks 5 min
- 2 Classification as a finance lease 1 mark 2 min
- 3 Gross and net investment 4 marks 7 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Short on time? Step 3 carries 4 of the 8 marks: guard its minutes.
Final answer
Check your own figures against these.
- Annual lease payment
- ₹3,60,00,000
- Gross investment
- ₹10,82,40,000
- Net investment
- ₹8,96,76,240
- Unearned finance income
- ₹1,85,63,760
Try it first. About 16 minutes for 8 marks. Write it out, then open the solution and check your figures against the final answer.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Step 1: the annual lease payment
The payments are structured so that the present value of the three year-end payments plus the present value of the residual value equals the cost. Annuity factor = 0.909 + 0.826 + 0.751 = 2.486.
| Cost of the equipment, split by present value | ₹ |
|---|---|
| PV of the payments (balancing figure: 8,96,76,240 − 1,80,240) | 8,94,96,000 |
| PV of the total residual value: (1,20,000 + 1,20,000) × 0.751 | 1,80,240 |
| Cost of the equipment | 8,96,76,240 |
- Annual lease payment = 8,94,96,000 ÷ 2.486 = ₹3,60,00,000.
The lease runs over the equipment's whole useful life, and the present value of the minimum lease payments is practically the whole cost (99.9%), above the 90%-of-cost feature of a finance lease; classification turns on the substance of the transaction rather than its form. A finance lease transfers substantially all the risks and rewards of ownership, unlike an operating lease, which runs for only part of the economic life. So this is a finance lease, and Zenith Ltd., the lessor, records it as such.
Step 2: gross investment, net investment and unearned finance income
Unearned finance income = gross investment − net investment.
| Particulars | ₹ |
|---|---|
| Minimum lease payments = payments (3 × 3,60,00,000) 10,80,00,000 + guaranteed residual value 1,20,000 | 10,81,20,000 |
| Gross investment = minimum lease payments 10,81,20,000 + unguaranteed residual value 1,20,000 | 10,82,40,000 |
| Particulars | ₹ |
|---|---|
| Net investment = PV of minimum lease payments 8,95,86,120 + PV of unguaranteed residual value 90,120 | 8,96,76,240 |
Reconciliation:
| Particulars | ₹ |
|---|---|
| Net investment in the lease | 8,96,76,240 |
| Add: Unearned finance income | 1,85,63,760 |
| Gross investment in the lease | 10,82,40,000 |
Unearned finance income = 10,82,40,000 − 8,96,76,240 = ₹1,85,63,760.
Result: annual lease payment ₹3,60,00,000 · gross investment ₹10,82,40,000 · net investment ₹8,96,76,240 · unearned finance income ₹1,85,63,760.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Annual payment derived from cost and the residual values | 3 |
| 2 | Classification as a finance lease | 1 |
| 3 | Gross and net investment; unearned finance income ₹1,85,63,760 | 4 |
| Total | 8 |
Report a problemopens an email to admin@getkunji.com with the question ID1406-Q5aalready filled in.