On
May 1, 2011, a machine was purchased for $1,750,000 by Pomeroy Corp. The
machine is expected to have an eight-year life with no salvage value and is to
be depreciated on a straight-line basis. The machine was leased to St. Isidor
Inc. on May 1, 2011, at an annual rental of $480,000. Other relevant
information is as follows:
1.
The lease term is three years.
2.
Pomeroy Corp. incurred maintenance and other executory costs of $61,000 for the
fiscal year ending December 31, 2011, related to this lease.
3.
The machine could have been sold by Pomeroy Corp. for $1,850,000 instead of
leasing it.
4.
St. Isidor is required to pay a rent security deposit of $65,000 and to prepay
the last month’s rent of $40,000 on signing the lease.
5.
Both Pomeroy and St. Isidor use IFRS.
Instructions
(a)
How much should Pomeroy Corp. report as income before income tax on this lease
for 2011?
(b)
What amount should St. Isidor Inc. report for rent expense for 2011 on this
lease?
(c)
What financial statement disclosures relative to this lease are required for
each company’s December 31, 2011 year end assuming private enterprise GAAP had
been used for each company?
(d)
What additional disclosures, if any, apply if both companies use IFRS?
(a) Annual
rental income ($480,000 X 8/12) $320,000
Less
maintenance and other executory costs (61,000 )
Depreciation
($1,750,000 ÷ 8 X 8/12)
(145,833 )
Income
before income tax $113,167
Note that any interest expense incurred by Pomeroy
would also be fully deductible for income tax purposes.
(b) Rent expense $320,000
Both the rent security deposit and the last month’s
rent prepayment should be reported as a non-current asset on St. Isidor’s books
and as a non-current liability on Pomeroy’s books.
(c)
Under
private enterprise GAAP:
The disclosure requirements for operating
leases from the point of view of the lessee are few and include:
1. The future minimum lease payments, in total and for
each of the next five years.
2. A description of the nature of other commitments such
as this lease.
For the
lessor, the disclosure recommended includes:
1. A description of the cost of property held for
leasing purposes and the amount of the accumulated depreciation.
2. The amount of rental income from operating leases.
3. Any impairment information.
(d)
Under IFRS
For the lessee, additional disclosures are required
about material lease arrangements including contingent rents, sub-lease
payments and lease-imposed restrictions.
For IFRS for operating leases, the lessor reports
information about the future minimum lease payments due within one year, years
two to five and after five years, as well as about the entity’s leasing
arrangements.
As well, the property interest under an operating
lease may be recognized as an investment property and accounted for under the
fair value model.
