Question 5 OR (a)
Lease: gross investment and unearned finance income
12 marks
- Time to write
- About 24 minutes
- Topic
- Leases and AS 19
- Notes
- Crux notes
Question
Question 5 OR (a) · 12 marksAB Ltd. leased a machine to AC Ltd. on these conditions:
| (₹) | |
|---|---|
| Fair Value of the Machine | 1,08,00,000 |
| Lease Period | 5 Years |
| Lease Rental | 18,00,000 p.a. |
| Guaranteed Residual Value (GRV) | 3,60,000 |
| Unguaranteed Residual Value (UGRV) | 6,48,000 |
| Internal Rate of Return | 15% |
The discounting factors for the 1st year to the 5th year are, in turn, 0.8696, 0.7561, 0.6575, 0.5718, and lastly 0.4972, respectively. Calculate:
the Gross Investment in Lease (GIL)
the Unearned Finance Income (UFI)
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
- CalculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
The printed fair value does not agree with the present value of the lease payments at the stated 15% and the printed factors. The unearned finance income is worked at the stated rate: the gross investment less its present value at 15%, as AS 19 defines it. The answer also shows the figure against the fair value.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Gross investment in the lease 4 marks 7 min
- 2 Present value of the rentals and residual values at 15% 5 marks 8 min
- 3 Unearned finance income 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Final answer
Check your own figures against these.
- Gross investment
- ₹1,00,08,000
- Unearned finance income
- ₹34,72,862.40
Try it first. About 24 minutes for 12 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.
Basis of the answer
- Gross investment in the lease is the minimum lease payments from the lessor's standpoint plus any unguaranteed residual value accruing to the lessor. For the lessor the minimum lease payments include the residual value guaranteed by or for the lessee.
- Unearned finance income is the gross investment less the present value of those payments and the unguaranteed residual value, at the interest rate implicit in the lease. The question gives that rate (15%) and its factors, so they are used.
- The rentals are taken as paid at the end of each year, matching the factors for years 1 to 5; the residual values arise at the end of year 5.
(i) Gross investment in the lease
| Item | ₹ |
|---|---|
| Lease rentals (18,00,000 × 5) | 90,00,000 |
| Guaranteed residual value | 3,60,000 |
| Unguaranteed residual value | 6,48,000 |
| Gross investment in the lease | 1,00,08,000 |
(ii) Unearned finance income
| Year | Amount receivable | ₹ | Factor at 15% | Present value ₹ |
|---|---|---|---|---|
| 1 | Rental 18,00,000 | 18,00,000 | 0.8696 | 15,65,280 |
| 2 | Rental 18,00,000 | 18,00,000 | 0.7561 | 13,60,980 |
| 3 | Rental 18,00,000 | 18,00,000 | 0.6575 | 11,83,500 |
| 4 | Rental 18,00,000 | 18,00,000 | 0.5718 | 10,29,240 |
| 5 | Rental 18,00,000 + GRV 3,60,000 + UGRV 6,48,000 | 28,08,000 | 0.4972 | 13,96,137.60 |
| Present value (net investment) | 65,35,137.60 |
Unearned finance income = gross investment 1,00,08,000 − present value 65,35,137.60 = ₹34,72,862.40.
Against the fair value. The printed fair value is ₹1,08,00,000, which does not agree with the present value at the stated rate. Measured against it, the figure would be 1,00,08,000 − 1,08,00,000 = ₹−7,92,000, which is negative and so cannot be an unearned income; the stated rate is used.
Result: gross investment ₹1,00,08,000; unearned finance income ₹34,72,862.40.
Where the 12 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Gross investment in the lease | 4 |
| 2 | Present value of the rentals and residual values at 15% | 5 |
| 3 | Unearned finance income | 3 |
| Total | 12 |
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