Sale and leaseback transactions
Entity E owns a machine with a carrying amount of CU 10 and a fair value of CU 12.8 as at Jan 01, 01. On Jan 01, 01, E sells the machine for CU 12.8 to entity F and leases the machine back starting the same date for a minimum lease payment of CU 4 p.a., payable at the end of each year. The lease term is four years. The economic life (IAS 17.4) and the useful life (IAS 17.4) of the machine are six years. There is no purchase option and no transfer of ownership by the end of the lease term. The machine is a standardized product that is also used by E”s competitors. It is not practicable for E to determine the interest rate implicit in the lease. E”s incremental borrowing rate of interest is 8% p.a.
Prepare any necessary entries in E”s financial statements as at Dec 31 for the year 01. Assume that in this example, apart from IAS 17.10, no further criteria are relevant for the classification as a finance lease or as an operating lease.