Application of Accurate Accounting Treatments - Essay Example

If under consideration the lease contract accepts ANY of the abovementioned tests, then it has to be treated as a finance lease otherwise it is an operating lease (Gitman, 2003).

As you mentioned, that plant being specialized in nature ownership will be transferred to Techme Ltd, hence, it falls in finance lease criteria. It is in an operating lease that accounts for rental expenses only. In a finance lease, the asset and liability both are recognized on the balance sheet and while making monthly payments liability decreases on one side, and the asset’s value decreases on the other side with depreciation account.

Going for a finance lease will impact your balance sheet with concerns of debt to equity ratio and return on assets as mentioned you wish to avoid. Also, it will impact your yearly profits for increased lease payments (Khan, 1993). Suitable to the current need of your balance sheet, it is advisable for Techme to opt for an operating lease as it will add the burden of rentals only in the income statement and will have no influence on returns and debt to equity ratio which is already almost near to maximum level. Also, the risks and burden of maintenance, insurance, and repair will also not lie with Techmeme.

Accounting treatment for both methods varies substantially. Operating lease only accounts for expenses in the income statement.
Accounting treatment of financial lease is as follow:
Recognition of financial lease:

INITIAL YEAR
Lease Asset XXXX           
Lease Liability     XXXX

This shall be recorded at a value that is lesser in FV of an asset or Present Value of Minimum Lease Payment. Moreover, if there is any other initial cost incurred then that will also be added to the asset, and cash will be credited as the following journal entry shows
Lease Liability XXXX

Cash   XXXX
Payment of installment for the first year will be paid in advance and since it is paid in advance therefore it would not include any interest expense.

SUBSEQUENT YEAR
Lease Liability XXXX

Interest Expense   XXXX
Cash    XXXX

Payment of the subsequent years will include liability as well as interest expenses for the year. The following journal entry shows the entry that has to be made in the following years.

Depreciation Expense XXXX
Accumulated Depreciation Expense             XXXX

Depreciation expense for the subsequent years.
Similar entries will go on for the life of the lease.
Journal entries that would need to be recorded in the last year
Accumulated Depreciation Expense XXXX

 Lease equipment XXXX

The lease asset is written off this year.

* Minimum lease payment is calculated as follows:

To remember used values are the present values of these MLP’s which are arrived at by discounting this value at interest agreed upon. 
Both Operating and Finance lease options are disclosed in financial statement disclosure with each providing respective details. The financial lease is not recorded in the balance sheet as assets and liabilities however the payments for the financial lease are recorded in the income statement. The financial lease liability is corded in the disclosure notes. On the other hand, an operating lease is recorded as an expense in the income statement. 

PROVISIONAL ACCOUNT
For your query regarding creating a provision let us go through this chat that will help you to be more specific in your decision.(National Treasury, 2012)

As we go through the information provided and the above flow chart, we will be moving along the red direction. Repair and maintenance that is to be incurred in future and according to what you have explained I feel this cost will be a possible obligation as a result of obligating event. Once the obligation certainty is decided, there comes the question of the possible outflow of the economic benefits. In your case, there is a surety that cost will incur, and hence, there is possible outflow. Therefore, it shall be recorded as a contingent liability.

Possibility to record provision arises when the present obligation has arisen and the uncertainty lies in the reliability of measures; whereas in your case repair need has not yet arisen and it is expected to arise somewhere in near future.  To mention, if the said outflow is expected in near future, as mentioned in the given information only then it will be recorded as disclosure and if the obligation is expected to arise in the remote future then it must be ignored.

You can also verify the decision with how much and at what time the obligation will be payable on the given graph: (National Treasury, 2012)Therefore, you need to record a contingent liability in disclosures notes to the financial statement. It will provide due information to the shareholders to reduce the pressure of increasing dividends.

Further comparison of bother has been given with example in the chart below: Given suggestions are subject to the given information; however, variation is possible in both cases with factors not provided in the case. It would be a pleasure to further elaborate if any areas are left unanswered or more information is required.