Reference no: EM132563020
Skyscraper Property (SP) is progressively building residential and commercial properties. After operating for 10 years, now the company enjoys the remarkable performance. The top management team is actively taking steps to ensure the company continuously grows. The corporate strategic planning team is given tasks to examine potential projects and opportunities that may help strengthen the company position. Meanwhile, the financial team is given tasks on financial planning and investment and the operational team is instructed to analyse options that company should take which in return help the operations of the company go smoothly. Below are snapshots of activities that have been taken by the teams.
Mr Fairul, who just graduated in accounting, is auditing the company's financial statement for the year ended 31 December 2018. He noticed that on 1 December 2017, the company entered into a leasing contract as follows:
i. The non cancellable term of 2 years.
ii. Rental of RM3,240 per year (paid on every 30 November). (The present value is RM5,778.)
iii. Estimated residual value after 2 years is RM1,100. SP guarantees the residual value of RM1,100.
iv. Estimated economic life of the asset is 5 years.
v. The implicit rate and SP's incremental borrowing rate is 8% per year.
In the company's accounting record, the company recorded the lease payment as rental expense. Mr Fairul asked Miss Farisha, an account clerk, why the company recorded as rental expense. Miss Farisha explained that, the lease contract does not meet the requirements to be classified as a finance lease as none of the test is met. Mr Fairul suspected that Miss Farisha referred to the old accounting standard.
Question:
Question 1: Discuss the above situation. In your discussion be sure to include (a) what you determined about the lease, and (b) how you advised the company to account for this lease. Explain every journal entry that you believe necessary to record this lease properly including the correction for the error made.