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ACCA Applied Skills · Financial Reporting · Leasing

Kestrel Co leases equipment for five years. The right-of-use asset is initially $300,000, made up of a lease liability of $270,000, initial direct costs of $10,000 and a prepayment of $20,000. The lease transfers ownership of the equipment to Kestrel at the end of the term. The equipment has a useful life of eight years and no residual value. What is the annual depreciation charge on the right-of-use asset, assuming straight-line depreciation?

Annual depreciation is $37,500. Because ownership passes to the lessee at the end of the lease, the right-of-use asset of $300,000 is depreciated over the eight-year useful life of the equipment rather than the five-year lease term.

  1. A$37,500Correct
  2. B$60,000
  3. C$33,750
  4. D$54,000

Explanation

Where ownership transfers at the end of the lease term, the right-of-use asset is depreciated over the useful life of the underlying asset, not the lease term. The charge is 300,000 / 8 = 37,500. Using the five-year lease term gives 60,000, which is wrong. Depreciating only 270,000 over 8 years gives 33,750, because it leaves out the other costs that form part of the asset.

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