On 1 July 2017, Orion Ltd leases a machine with a fair value of $69 594 to Triton Ltd for 5 years at an annual lease payment of $16 000. The lease is cancellable, but a penalty equal to 50% of the total lease payments is payable on cancellation. Triton Ltd does not intend to buy the machine at the end of the lease term. Orion Ltd incurred $2 000 to negotiate and execute the lease agreement. Orion Ltd purchased the machine for $69 594 just before the inception of the lease.
Extra information: (Orion purchased the machine from Triton Ltd. Carrying amount for Triton was $65,000.)
The Lease agreement details are as follows:
|Length of lease||5 years|
|Annual lease payment, payable 30 June each year||$16 000|
|Fair value of the machine at 1 July 2016||$69 594|
|Estimated economic life of the machine||8 years|
|Estimated residual value of the plant at the end of its economic life||$4 000|
|Residual value at the end of the lease term, of which 50% is guaranteed by Triton Ltd||$14 400|
|Interest rate implicit in the lease||9%|
1-Does the Orion Ltd lease arrangement involves a finance lease or an operating lease? Justify your choice.
2- Critically evaluate the accounting treatment adopted by Triton Ltd with respect to the sale and leaseback agreement. Refer, where necessary, to relevant sections of AASB 117.
Extra guide: Comment on the advantage for Triton Ltd in selling and leasing back the machinery. (Note the question refers to Triton, not Orion as previously printed in error.)