Example of Operating Lease

Example of Operating Lease

A lease which is not a finance lease is considered to be an operating lease. The general condition for the finance lease classification is transfer of risk and reward to the lessee. The operating lease is more like a rental arrangement and rent is charged to the income statement.

For example plant is leased by the ABC & Co for annual rent of $ 2000. The transaction is reflected as under

Date	Particular	Dr.	Cr.
	Rental  a/c	$2,000
	Cash  a/c		$2,000

Example of Operating Lease (Straight Line Bases)

Rental payment is charged to income statement on straight line bases.

Leased plant	2 years
Useful life	10 years
Rental ( at year end)	$ 5,000
Advance payment	$ 2,000

Solution

Step 1. Calculate the annual rent on straight line bases

Step 2. Charge the annual rental to income statement

Step 3. Prepayment if any are accounted for in statement of finance position

Step 1 Annual Rental Calculation

(2 years x $ 5,000)+ 2000/ 2 years

= 6,000 annual rental

Step 2 . Charge annual Rental to income statement

Date	Particular	Dr.	Cr.
	Rental  a/c	$6,000
	Cash  a/c		$6,000

Step 3  Record the prepayment in Balance sheet

The difference between amount paid and the amount charged to the income statement is prepayment and therefore appear as asset in the financial statement.

Total payment  ( $ 5,000 + $ 2000)	$ 7000
Annual Rental	$ 6,000
Balance sheet ( Statement of Financial position)	$ 1000

Total payment includes the advance payment and rental paid during the year. This is important learning point that annual rental paid during the year and rental charge may be differ due to the advance payment because advance payment is also accounted for while calculating the rental expenses for the year.

Examples of Finance Lease

Examples of Finance Lease

The lease can be classified as finance lease if risks and rewards associated with asset are transferred to lessee. The associated risks may classify into repairing cost, insurance costs, maintenance cost and risk of obsolescence. The rewards are the maximum economic benefit is utilized by the lessee and use without any limitation.

Example # 1 Finance lease and Repair Cost

ABC Company took an asset on lease for 2 years the economic life of the asset is 10 years. Repair and maintenance is responsibility of lesser. Classify lease type?

In above case lessee is using only 20% of economic life of the asset therefore the reward associated with asset remains with lesser , moreover , repair cost also responsibility of lesser that means that risks associated with asset is also not transferred to lessee, Therefore this lease is operating lease.

Example # 2 Finance Lease and obsolescence

ABC Company enters with a contract with XYZ Company to lessee a plant and machinery for 6 years having useful life of 8 years. ABC may return the asset any time due to obsolescence.

In above example although company is using the maximum economic life of the asset i.e. reward, however, risk remain with the lesser as asset can be returned any time, therefore this lease is operating lease.

Example # 3 Finance lease and buy option

ABC Co took a plant from XYZ at cost of $ 2 million; the plant has useful life of 3 years but can be use for further 3 years with some modification and repair expenditure of $.5. XYZ require the return of asset at the end of 3 year and no buy option is available.

This lease does not carry the buy option and reward associated at the end of useful life is not transferred to lessee therefore this is operating lease.

Example # 4 Finance lease and cancellation

ABC Company takes machinery on lease from Raheel & Co for 5 year (useful life 5 year). The lease contract has option of cancellation option by the lesser any time.

In this example the rewards are not fully transferred to the lessee i.e. can be cancelled any time, Therefore this is an operating lease.

Examples of Unprocessed Data

Examples of Unprocessed Data

Data is basically unprocessed information and therefore cannot be generally used for decision making. Therefore data is processed for decision making. Data processing may include but not limited to the classification, sorting, applying different mathematical processes and formula on data and presentation of data.

Example # 1

The data collected and provided to you that total number of vehicle passing the bridges is 10,000 per day and tool for the bridge crossing is $ 2, $ 4, and $ 6 for the cars, wagons and Trucks respectively. The contract price of bridge toll collection is 8 million Dollars. What should be the bid price?

In above information data is need to be further processed for decision making because unless and until the number of vehicles crossing the bridges is categories into cars , wagons and trucks, It is not possible to make an appropriate decision about the bidding price.

 if the data is processed and information is generated like that the there are 2000 cars , 4000 wagons and 4000 trucks are crossing the bridge ,then this information can be used for decision making.

Example # 2

There are two products A and B which has the direct material cost $ 2 and $ 4, direct labor cost $ 4, $ 2 and direct Expenses $ 5, $ 2. Set the selling price for the product.

The data presented above to the management is not in the form to facilitate decision making, management need product price for setting price and ideally the data must further be processed to facilitate decision making. The following presentation of data is more relevant to for decision making.

	Product A	Product B
Direct  material	$ 2	$ 4
Direct Labor	$ 4	$ 2
Direct Expenses	$ 5	$ 2
	$11	$8

Example # 3

Management was informed that during the year revenue remained $ 205 million and the salaries expenses for the year were $ 31, selling expenses $ 25, financial expenses $ 56, Administration expenses $ 45. The management is required to assess the performance of the organization.

The data presented above is need further processing for performance evaluation and data is ideally be processed and presented as follow.

Revenue	$ 205
Less :Expenses ($ 31+$25+$56+$45)	$ 157
Profit	$   48

Example of Marginal Costing and Closing inventory

Example of Marginal Costing and Closing inventory

Closing inventory in marginal costing is valued at variable cost. Due to valuation at variable cost the profit under marginal costing differ from profit under absorption costing because under absorption costing stock valuation is performed at full production cost.

Example

Sales Price	500 per unit
Direct Material	200 per unit
Direct Labor	50  per unit
Direct Expenses	50  per unit
Rent of Factory	60,000
Rent of warehouse	60,000
Output produced and Sold	1,800 & 1500 units

Calculated profit and stock valuation under Marginal Costing

Solution

This example can be solved by two methods

Method 1

Under this method variable production cost of unit sold is deducted from the sales price and closing inventory is separately valued for inclusion in balance sheet. Closing inventory valuation under this method does not form part of profit/contribution calculation.

1. Profit Calculation

	Units	Rate	Total
Sales	1500	500	750,000
Less: Variable Cost	1500	(200+50+50)=300	(450,000)
Contribution			300,000
Less: Fixed Cost		(60,000+60,000)	(120,000)
Profit			180,000

2. Stock Valuation

	Unit	Rate	Amount
Closing Stock	300 units	300	90,000

Method 2

Under this method variable production cost of unit sold is calculated and closing inventory therefore form part of profit /contribution calculation.

 Profit Calculation

	Units	Rate	Total	Total
Sales	1500	500		750,000
Production Cost	1800	(200+50+50)=300	540,000
Less Closing Stock	300	300	(90,000)
Variable Production Cost				(450,000)
Contribution				300,000
Fixed Cost				(120,000)
Profit				180,000

Example of Marginal Costing

Example of Marginal Costing

Marginal costing also known as variable costing method under which only variable cost is deducted from the sales to calculate contribution and fixed cost is deducted as period cost. Under marginal costing the stock is also valued at variable cost therefore the profit calculated under marginal costing differ from the profit calculated under absorption costing.

Example of Marginal Costing without inventory

In following example the basic concept of marginal costing has explained.

Sales Price per unit	400 per unit
Direct Material	260 per unit
Skilled Direct Labor	30  per unit
Direct Expenses	30   per unit
Lightening of Factory	50,000
Heating Factory	50,000
Output produced and Sold	1500 units

Calculated profit under Marginal Costing

Solution

	Units	Rate	Total
Sales	1500	400	600,000
Less: Variable Cost	1500	(260+30+30)= 320	(480,000)
Contribution			120,000
Less: Fixed Cost		(50,000+50,000)	(100,000)
Profit			20,000

In first place the total contribution is calculated by deducting the variable cost from the sales and then fixed cost is deducted as period cost.