Final illustrative example - when a lease term changes
Sikiru Salami FCA MRM
Finance Director| CFO| Global Finance Leader with expertise in corporate strategy, financial reporting, capital raising, project management and enterprise risk management.
Illustration 8 (Where the terms of the lease change along the line)
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HFA Holdings Limited secured a lease for its warehouse under the following terms:
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Lease Amount: N25million per annum for five years.
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The agreement sets an implicit interest rate of 18%.
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However, by the end of year 1, HFA agreed with the Lessor to extend the lease tenor to 7 years.
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A new lease payment of N35million per annum was agreed upon.
What are the carrying amount of the right-of-use asset and the lease liability at the end of year 2, and applicable entries?
Solution
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Since there is a change in the terms of the lease, you will have to prepare two amortization tables.
Amortization Table for the first terms
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-????????? The lease period is 5 years and the Right-of-Use Asset to be depreciated over the same period. (78,179,276 /5= 15,635,855)
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At Initial Recognition
Debit: Right-of-Use Asset?????????????????????????? (With N78.17million, being the fair value of the lease based on earlier terms)
Credit: Lease Liability Account?????????????????
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1.??????? At First Year-end
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Debit: Lease Liability???????????????? (With N10.9million, being the principal repaid on the lease liability by Year 1)
Debit: Interest Expense??????????? (With N14.1million, being the interest due on the lease liability in Year 1)
Credit: Bank Account ?????????????? (With N25million, being the lease payment for year 1)
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Debit: ROU Depreciation Expense?????????? (With N15.6million, being the ROU Depreciation for Year 1)
Credit: Accumulated ROU Depreciation
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Carrying Amount of Lease Liability by end of Year 1: Fair value of lease minus principal repayment in Year 1
78,179,276 – 10,927,730 = N67,251,545
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Carrying Amount of Right-of-Use Asset by end of Year 1: Cost of Right of Use Asset minus ROU Depreciation expense in Year 1
78,179,276 - 15,635,855 =? N62,543,420
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By the end of first year, the terms changed. New terms to apply going forward
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New tenor: 7 years (inclusive of Year 1 already expended. So, 6 more years to go)
New lease payment: N35million per annum
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Amortization Table for the new terms
Carrying Amount of Lease Liability by end of Year 1: Fair value of lease minus principal repayment in Year 1
78,179,276 – 10,927,730 = N67,251,545. Without change in terms, this should have been the Opening Balance for Year 2.
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However, the change in terms, led to a new Fair Value by beginning of Year 2:
Put this on Excel spreadsheet: PV(18%;6;35,000,000)=122,416,090
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Therefore, two things will happen:
-????????? Adjust for the difference between the Year 1 Carrying Balance and the new Fair Value
122,416,090 - 67,251,545 =? 55,164,544
-????????? Compute new ROU Depreciation figure:
New Right-of-Use Asset figure:
Carrying Amount of Right-of-Use Asset by end of Year 1: N62,543,420
Plus, Adjustment for change in lease terms??????????? ????????? 55,164,5445????????????????????? ???????
?????????????????????????????????????????????????????????????????????????????????????????117,707,964
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New ROU Depreciation charge: 117,707,964/(7-1 ) = 19,617,994
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2.??????? At Second Year-end:
i.???????? Debit: Right-of-Use Asset????????????????? (With N55.1million, being the incremental impact new lease terms)
Credit: Lease Liability????????????????????????
ii.??????? Debit: Lease Liability??????? (With N12.97million, being the principal repaid on the lease liability by Year 2)
Debit: Interest Expense?? (With N22.03million, being the interest due on the lease liability in Year 2)
Credit: Bank Account ????? (With N35million, being the lease payment for Year 2)
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Debit: ROU Depreciation Expense?????????? (With N19.6million, being the ROU Depreciation for Year 2)
Credit: Accumulated ROU Depreciation
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Carrying Amount of Lease Liability by end of Year 2: Carry amount of lease liability minus principal repayment in Year 2
122,416,090 – 12,965,104 = N109,450,986
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Carrying Amount of Right-of-Use Asset by end of Year 1: Carrying amount of Right of Use Asset minus ROU Depreciation expense in Year 2
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117,707,964 - 19,617,994 =? N98,089,970
Finance Professional at Alzheimer’s Society
9 个月Thank you for your insightful analysis. Please can you look at the Interest payment & Principal repayment paid in year 2 that you debited to Interest Exp. and Lease Liability a/c. It appears that you mistakenly picked the value for year 3.