On 1 January 20X1, Oryx entered into a contract to lease a specialised machine for three years. The contract contains an option to extend the lease term for a further year. Oryx believes that it is reasonably certain to exercise this option. The machine has a usefut life of ten years.
Oryx will make lease payments of $1 million per year for the initial term and
SO 8 million per year for the option period. All payments are due at the end of the year. To obtain the lease, Oryx incurs inital direct costs of SO 1 milion.
The interest rate within the lease is not readily determinable. Ory's incremental rate of borrowing is 10%
What entries will Oryx post on 1 January 20X1 in respect of this lansa?
To determine the accounting entries Oryx will post on 1 January 20X1 regarding the lease of the specialized machine, we need to calculate the present value of the lease payments and recognize the rightofuse asset and lease liability.
1.
Lease Payments:
 For the initial three years: $1 million per year.
 For the optional fourth year:$8 million.
2.
Present Value Calculation:
Since the interest rate is not readily determinable, we will use Oryx's incremental borrowing rate of 10%.

Present Value of Lease Payments for the Initial Term (3 years):
$PV = \sum \left( \frac{C}{(1 + r)^t} \right)$
Where $C$ is the cash flow ($1 million), \(r\) is the interest rate (10%), and \(t\) is the year.
\[
PV = \frac{1,000,000}{(1 + 0.10)^1} + \frac{1,000,000}{(1 + 0.10)^2} + \frac{1,000,000}{(1 + 0.10)^3}
\]
\[
PV = 909,091 + 826,446 + 751,315 = 2,486,852
\]

Present Value of Lease Payment for the Optional Year:
$PV = \frac{8,000,000}{(1 + 0.10)^4} = \frac{8,000,000}{1.4641} \approx 5,464,000$

Total Present Value of Lease Payments:
$Total PV = 2,486,852 + 5,464,000 = 7,950,852$
3.
Initial Direct Costs:
Oryx incurs initial direct costs of $1 million, which will be added to the rightofuse asset.
4.
Journal Entries on 1 January 20X1:

RightofUse Asset:
$RightofUse Asset = Total PV + Initial Direct Costs = 7,950,852 + 1,000,000 = 8,950,852$

Lease Liability:
$Lease Liability = Total PV = 7,950,852$
The journal entries will be:
 Debit RightofUse Asset: $8,950,852
 Credit Lease Liability:$7,950,852
 Credit Cash (or Accounts Payable) for Initial Direct Costs: $1,000,000
This reflects the recognition of the rightofuse asset and the corresponding lease liability on Oryx's balance sheet. If you have any further questions or need clarification on any part of this process, feel free to ask!
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