Possibly stupid debits/credits question

Newaglish

I don't know if i'm just having an incredible mind blank, but how do I treat the following transaction:

Lessee rents machine for €200 per month from 1 May 2006.
On top of rent, pays deposit of €1,500 to be returned at the end of the six-year lease, provided there's no damage etc.

So, obviously, the rent is handy enough. But what do I do with the deposit? Apparently I can't just expense it in 2006 and gain it in 2012.

Is it some sort of non-current asset (long-term prepayment?). That sounds ridiculous.

The answer is staring me in the face and I can't figure it out!

To add to my shame; i'm not a Leaving Cert student. I'm a BA graduate sitting my Prof 3 exams next week

chump

am doing the same exam and am fupped, not to worry tho...

1 thing sprung to mind

Cr Bank
Dr Receivable
Ultimately doesn't hit p/l

Good question tho ... post up the answer here

Newaglish

Yo chump,

Yeah, that's kinda what I though but then don't you have a receivable sitting on your balance sheet for a very long time?

chump

Newaglish wrote:

Yo chump,

Yeah, that's kinda what I though but then don't you have a receivable sitting on your balance sheet for a very long time?

Newaglish I definitely don't think what I wrote is correct - it doesn't make sense much sense. Even if it was the right treatment the present value of the receivable doesn't equal what was paid out - therefore it's not accurate. You'd have to expense the difference over the life of the lease.

hivizman

Chump, your first thought is absolutely correct, you just debit receivables with the amount of the deposit.

Now for the science! The deposit meets the definition of a financial asset under IAS32 (it's a contractual right to receive cash from another entity). There are four classifications of financial assets: at fair value through profit or loss; available for sale; loans and receivables; held to maturity. The relevant classification is loans and receivables, which are 'non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than those the entity expects to sell immediately or in the short term, and those that the entity on initial recognition designates as either at fair value through profit and loss or available for sale' (IAS39, para. 9).

Loans and receivables are measured at amortised cost using the effective interest method. That means that you have to work out what the effective interest rate in the deposit is, and it's simply zero, as the 'cost' of the receivable is 1,500 and you expect to get back 1,500. I'm assuming that you don't expect at the outset to incur damages! So at all times the 'amortised cost' measurement is equal to the nominal value of the deposit, and there's no profit and loss account impact.

Newaglish

Interesting work!

So how do I present it?

Non Current Assets

Receivables 1500


This is the bit that I found most unusual.

chump

hivizman wrote:

Chump, your first thought is absolutely correct, you just debit receivables with the amount of the deposit.

Now for the science! The deposit meets the definition of a financial asset under IAS32 (it's a contractual right to receive cash from another entity). There are four classifications of financial assets: at fair value through profit or loss; available for sale; loans and receivables; held to maturity. The relevant classification is loans and receivables, which are 'non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than those the entity expects to sell immediately or in the short term, and those that the entity on initial recognition designates as either at fair value through profit and loss or available for sale' (IAS39, para. 9).

Loans and receivables are measured at amortised cost using the effective interest method. That means that you have to work out what the effective interest rate in the deposit is, and it's simply zero, as the 'cost' of the receivable is 1,500 and you expect to get back 1,500. I'm assuming that you don't expect at the outset to incur damages! So at all times the 'amortised cost' measurement is equal to the nominal value of the deposit, and there's no profit and loss account impact.

Thanks for the quality reply - don't see too many of those around here!