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On 1st January 2000, Ali (Pvt.) Ltd. signed a contract of lease financing with Mahmood (Pvt.) Ltd. The brief details of the contract are as follows:
The leasing contract is about a piece of machine for the period of 6 years which will be used in the operations of the business. The cost of machine is Rs. 350, 000.
The interest rate to be applied to the six payments is 15%.
Lessor and lessee (Ali and Mahmood) cannot terminate the lease contract at any stage
of lease financing.
It is estimated the annual lease rentals will be paid at the end of each year (on 31st
December of every year).
Estimated annual lease rental is Rs. 92,500.
Estimated residual value is 0 for the machinery and useful economic life of the machine
is 8 years.
Ali (Pvt.) Ltd. uses straight line method of depreciation for all categories of assets.
Net profit for the Ali (Pvt.) Ltd. for the year 2000 is Rs. 185,000
Based on the above information, you are required to answer the following questions:
a) Show how Ali (Pvt.) Ltd. will account for the above transaction in its statement of financial position at 31st December 2000, in accordance with the principles laid down in IAS 17.
b) Also, show the effects of Lease agreement in Income statement and cash flow statement of the entity (suppose Ali (Pvt.) Ltd. is using indirect method for the preparation of cash flow statement).
c) Explain why the need of standardization of lease agreements, was felt by the standard setters (FASB) and discuss some of the rationales behind the approach adopted by the standard setters.
d) The lessor has suggested that the lease could be drawn up with a minimum payment period of one year and an option to renew. Discuss with logical points that why this option might be attractive to the lessee.
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