Question 4 a Marstock has leased an item of plant under the

Question 4 a) Marstock has leased an item of plant under the following terms Commencement of the lease was 1 January 20X2 Term of lease 5 years Annual payments in advance $12,000 Cash price and fair value of the asset- $52,000 at 1 January 20X2-equivalent to the present value of the minimum lease payments Implicit interest rate within the lease 8% per annum The company\'s depreciation policy for this type of plant is 20% per annum on cost Required: Explain which criteria are satisfied in order for the above lease to be classified as a finance lease. (0) 4 marks (i) Prepare extracts of the income statement and statement of financial position for Marstock for the year to 31 December 20x3 for the above lease and show your workings. Make sure to show current and non-current liabilities separately. 10 Marks b) Briefly explain the capital maintenance concept and why creditors require protection. Provide two reasons why companies may reduce their capital. 6 marks Total 20 marks

Solution

(i). A lease is classified as a financial lease, if it satisfies the following condition:

The lease term is for the major part of the economic life of the asset even if title is not transferred.

In the given case, term of lease=5 years. company\'s deprecation rate=20% p.a. on cost i.e. the asset will get fully depreciated by the end of 5th year. Term of lease=life of asset.

Therefore this lease is to be considered as Financial lease.

(ii).

All the lease payments are received as payment in advance.

Unearned Finance income:

Total lease payments(12000*5) 60000

Add: Residual value -

Gross investments =60000

Less: Present value of investment (51744)

Unearned Finance Income =8256

Segregation of finance income:

Profit&loss Account:(Relevant extracts)(credit side)

2013 By finance income 2473.88

Balancesheet(relevant extracts)

31.12.13 Lease receivable 39744

Less: Amount received (8820.48) 30923.52

Beginning of the year	Lease payments	PVF@8%	PV
2012	12000	1	12000
2013	12000	0.926	11112
2014	12000	0.857	10,284
2015	12000	0.794	9528
2016	12000	0.735	8820
		TOTAL	51744