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ACCOUNTING FOR LEASES (PAS 17)

PRACTICAL ACCOUNTING I MICHAEL B. BONGALONTA,CPA,MICB,MBA

SAMPLE PROBLEMS

PROBLEM 1(adapted): Presented below are three different aircraft lease transactions that
occurred for Midwest Airways in 2002. All the leases start on January 1, 2002. In no case
does Midwest receive title to the aircraft during or at the end of the lease period; nor is
there a bargain purchase option.

Lessor
Unruh Insurance Maris Leasing Gregg Leasing
Type of property 747 Aircraft 727 Aircraft L-1011 Aircraft
Yearly rental $5,908,781 $4,954,021 $2,851,861
Lease term 15 years 15 years 20 years
Estimated economic life 25 years 25 years 25 years
Fair market value of
leased asset $55,000,000 $49,000,000 $32,000,000
Present value of lease
rental payments $50,000,000 $42,000,000 $28,000,000

Instructions:
(a) Which of the above leases are operating leases and which are capital leases?
(b) How should the lease transaction with Unruh Insurance be recorded in 2002?
(c) How should the lease transaction with Maris Leasing be recorded in 2002?

PROBLEM 2 (adapted): Mott Corporation entered into the following transactions:

1. Gant Car Rental leased a car to Mott Corporation for one year. Terms of the operating
lease call for monthly payments of $750.

2. On January 1, 2002, Mott Corporation entered into an agreement to lease 20 machines

from Weiss Corporation. The terms of the lease agreement require an initial payment of
$125,000 and then three annual rental payments of $150,000 beginning on December
31, 2002. The present value of the three rental payments is $373,027. The lease is a
capital lease.

Instructions: Prepare the appropriate journal entries to be made by Mott Corporation in

January related to the lease transactions.

PROBLEM 3 (adapted): Rapp Co. leased a new machine to Lake Co. on January 1, 2003.
The lease is an operating lease and expires on January 1, 2008. The annual rental is
$90,000. Additionally, on January 1, 2003, Lake paid $50,000 to Rapp as a lease bonus and
$25,000 as a security deposit to be refunded upon expiration of the lease. In Rapp’s 2003
income statement, the amount of rental revenue should be:

PROBLEM 4 (adapted): On January 1, 2003, Wren Co. leased a building to Brill under an
operating lease for ten years at $50,000 per year, payable the first day of each lease year.
Wren paid $15,000 to a real estate broker as a finder’s fee. The building is depreciated
$12,000 per year. For 2003, Wren incurred insurance and property tax expense totaling
$9,000. Wren’s net rental income for 2003 should be:

PROBLEM 5 (adapted): On January 1, 2003, Park Co. signed a ten-year operating lease for
office space at $96,000 per year. The lease included a provision for additional rent of 5% of
annual company sales in excess of $500,000. Park’s sales for the year ended December 31,
2003, were $600,000. Upon execution of the lease, Park paid $24,000 as a bonus for the
lease. Park’s rent expense for the year ended December 31, 2003, is:

PROBLEM 6 (adapted): Peg Co. leased equipment from Howe Corp. on July 1, 2003 for an
eight-year period expiring June 30, 2011. Equal payments under the lease are $600,000
and are due on July 1 of each year. The first payment was made on July 1, 2003. The rate
of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment
is $3,520,000, and the cost of the equipment on Howe’s accounting records is $2,800,000.
The lease is appropriately recorded as a sales type lease. What is the amount of profit on
the sale and interest revenue that Howe should record for the year ended December 31,
2003?

PROBLEM 7 (adapted): On December 31, 2003, Day Co. leased a new machine from Parr
with the following pertinent information:

Lease term 6 years

Annual rental payable at beginning of each year $50,000
Useful life of machine 8 years
Day’s incremental borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of annuity of 1 in advance for 6 periods at
12% 4.61
15% 4.35

The lease is not renewable, and the machine reverts to Parr at the termination of the lease.
The cost of the machine on Parr’s accounting records is $375,500. At the beginning of the
lease term, Day should record a lease liability of:

PROBLEM 8 (adapted): On January 1, 2003, Day Corp. entered into a ten-year lease
agreement with Ward, Inc. for industrial equipment. Annual lease payments of $10,000 are
payable at the end of each year. Day knows that the lessor expects a 10% return on the
lease. Day has a 12% incremental borrowing rate. The equipment is expected to have an
estimated useful life of ten years. In addition, a third party has guaranteed to pay Ward a
residual value of $5,000 at the end of the lease.

The present value of an ordinary annuity of $1 at:

12% for ten years is 5.6502
10% for ten years is 6.1446
The present value of $1 at:
12% for ten years is .3220
10% for ten years is .3855

In Day’s October 31, 2003 balance sheet, the principal amount of the lease obligation was

PROBLEM 9 (adapted): On December 30, 2003, Rafferty Corp. leased equipment under a
capital lease. Annual lease payments of $20,000 are due December 31 for ten years. The
equipment’s useful life is ten years, and the interest rate implicit in the lease is 10%. The
capital lease obligation was recorded on December 30, 2003, at $135,000, and the first
lease payment was made on that date. What amount should Rafferty include in current
liabilities for this capital lease in its December 31, 2003 balance sheet?

PROBLEM 10 (adapted): East Company leased a new machine from North Company on May
1, 2003, under a lease with the following information:

Lease term 10 years

Annual rental payable at beginning of each lease year $40,000
Useful life of machine 12 years
Implicit interest rate 14%
Present value of an annuity of one in
advance for ten periods at 14% 5.95
Present value of one for ten periods at 14% 0.27

East has the option to purchase the machine on May 1, 2013 by paying $50,000, which
approximates the expected fair value of the machine on the option exercise date. On May 1,
2003, East should record a capitalized lease asset of:
PROBLEM 11 (adapted): On January 1, 2003, Hooks Oil Co. sold equipment with a carrying
amount of $100,000, and a remaining useful life of ten years, to Maco Drilling for $150,000.
Hooks immediately leased the equipment back under a ten-year capital lease with a present
value of $150,000 and will depreciate the equipment using the straight-line method. Hooks
made the first annual lease payment of $24,412 in December 2003. In Hooks’ December
31, 2003 balance sheet, the unearned gain on equipment sale should be:

PROBLEM 12 (adapted): On July 1, 2014, Radium Inc. leased a delivery truck from Titanium
Corp. under a 3-year operating lease. Total rent for the term of the lease will be P360,000
payable as follows:
12 months at P5,000 per month P60,000
12 months at P7,500 per month 90,000
12 months at P17,500 per month 210,000

All payments were made when due. In Radium’s June 30, 2016 balance sheet, what amount
should be reported as accrued rent payable?

PROBLEM 13 (adapted): As an inducement to enter a lease, Athena, a lessor, grants Zeus

Corp. a lessee, months of free rent under a 5-year operating lease. The lease is effective
July 1, 2014 and provides for a monthly rental of P20,000 to begin April 1, 2015.
In Zeus income statement for the year ended June 30, 2015. How much should be reported
as rent expense?

PROBLEM 14 (adapted): On January 1, 2014, Peter Pan Company sold equipment with the
carrying amount of P1,000,000 and a remaining economic life of 10 years to Koko Drilling
for P1,500,000. Peter Pan immediately leased the equipment back under a 10-year finance
lease payment of P244,120 in December 2014.
In December 31, 2014 statement of financial position, how much should be the adjusted
unearned gain on equipment sale?

PROBLEM 15 (adapted): The following information pertains to a sale and operating

leaseback of equipment by Germanium Co. on December 31, 2014:
Sale price P640,000
Carrying amount P500,000
Monthly lease payment P 24,457
Estimated remaining life 25 years
Lease term 2 years
Implicit rate 12%
Fair value P540,800
What amount of deferred gain on the sale should Germanium report at December 31, 2014?

PROBLEM 16 (adapted): On June 30, 2014, Potassium Company sold an equipment with an
estimated economic life of 10 years and immediately leased it back for 8 years. The
equipment’s carrying amount was P450,000, the sales price was P430,000.
What amount should Potassium report as deferred loss on its June 30, 2014 statement of
financial position?

PROBLEM 17 (adapted): On January 2, 2014, Dioxide Mining Co. (lessee) entered into a 5-
year lease for drilling equipment. Dioxide accounted for the acquisition as a finance lease for
P2,400,000 which includes a P100,000 bargain purchase option.
Dioxides estimates that the equipment fair value will be P200,000 at the end of its 8-year
economic life. Dioxide regularly uses straight-line depreciation on similar equipment.
For the year ended December 31, 2014, what amount should Dioxide recognize as
depreciation expense on the leased asset?

PROBLEM 18 (adapted): Start Company leased a new machine from End Company on
December 31, 2014 under a lease agreement with the following pertinent information:

Lease term 10 years

Annual rental payable at the beginning of each year P200,000
Economic life of the machine 15 years
Implicit interest rate 10%
Present value of an annuity of 1 in advance for periods at 10% 6.76
Present value of 1 for 10 periods at 10% 0.39
Start Company has the option to purchase the machine on December 31, 2014 by paying
P250,000, which is significantly less than P500,000 expected fair value of the machine on
the option exercise date. Assume that at the inception of the lease, how much should Start
Company record as a lease liability?

PROBLEM 19 (adapted): Glade Company leases computer equipment to customers under a

direct financing lease. The equipment has no residual value at the end of the lease and the
lease does not contain bargain purchase option. Jade wishes to earn 8% interest on a 5-
year lease of equipment with a cost of P3, 234, 000. The present value of an annuity due of
1 at 85 for 5 years is 4.312. On January 1, 2011, Glade Company leased the equipment to
Blass Company.
1. What is the total interest revenue that Glade will earn over the lease term?
2. What is the interest revenue to be reported by Glade for 2011?

PROBLEM 20 (adapted): Cassandra Company acquired a specialized packaging machine for

P3, 000, 000 cash and leased it for a period of six years, after which the machine is to be
returned to Cassandra Company. The unguaranteed residual value of the machine is P200,
000. The lease terms are arranged so that a return of 12% is earned by Cassandra. The PV
of an annuity in advance of 1 at 12% for six periods is 4.60, and the PV of 1 at 12% for six
periods is .51. What is the annual lease payment payable in advance required to yield the
desired return?

PROBLEM 21 (adapted): Camia Company is in the business of leasing new sophisticated

equipment. As a lessor, Camia expects a 12% return on its net investment. All leases are
classified as a direct financing lease. At the end of the lease term, the equipment will revert
to Camia Company.
On January 1, 2011 an equipment is leased to another entity with the following information.
Cost of equipment to Camia 5, 500, 000
Residual value-unguaranteed 400, 000
Annual rental payable in advance 959, 500
Useful life and lease term 8 years
Implicit interest rate 12%
First lease payment January 1, 2011

1. What is the unearned interest income on January 1, 2011?

2. What is the interest income for 2011?

PROBLEM 22 (adapted): Luna Corporation is in the business of leasing new sophisticated

computer systems. As a lessor of computers, Luna purchased a new system on December
31, 2009. The system was delivered the same day (by prior arrangement) to General
Investment Company, a lessee. The Corporation accountant revealed the following
information relating to the lease transaction:
Cost of system to Luna P550, 000
Estimated useful life and lease term 8 years
Expected residual value (unguaranteed) P40, 000
Luna’s implicit rate of interest 12%
General’s incremental borrowing rate 14%
Date of first lease payment December 31, 2009

Additional information is as follows:

(a) At the end of the lease, the system will revert to Luna.
(b) General is aware of Luna’s rate of implicit interest.
(c) The lease rental consists of equal annual payments.

1. What is the annual lease payment under the lease?

2. What is the total financial revenue to be earned by the lessor over the lease term?
3. What is the interest income to be recognized by the lessor in 2010?
4. What is the total expenses related to the lease that will be recognized by the lessee
in 2010?
5. What is the amount to be reported under current liabilities as liability under finance
lease as of December 31, 2010?
PROBLEM 23 (adapted): On January 1, 2011, Tripoli Company sold a machine to another
entity for P3,000,000. The fair value on the date of sale was P3,500,000. The machine had
a carrying amount of P4, 000,000, and remaining life of 10years. The entity immediately
leased back the machine at an annual rental of P60, 000 for 4years. It was determined that
the annual rental is sufficiently lower compared to the market rent of some asset. What is
the total amount to be recognized by the entity in profit or loss for 2011?

PROBLEM 24 (adapted): On January 1, 2011, Gallant Company entered into a lease

agreement with Blacksheep Company or a machine which was carried on the accounting
records of Gallant of P2,000,000. Total payments under the lease which expires on
December 31, 2020, aggregate P3,550,800 of which P2,400,000 represents cost of the
machine to Blacksheep. The interest rate of 10% which was stipulated in the lease is
considered fair and adequate compensation to Gallant for the use of its funds. Blacksheep
expects the machine to have a 10year life, no residual value and be depreciated on a
straight line basis. The lease is conceived as sales type lease. What should be the total
income before income tax derived by Gallant from the lease for the year ended December
31, 2011?

PROBLEM 25 (adapted): Easter Company leased equipment to Faye Company on January 1,

2011. The lease is for an eight-year period expiring December 31, 2018. The first of eight
equal annual payments of P900,000 was made on January 1, 2011. Easter had purchased
the equipment on December 29, 2010 for P4,800,000. The lease is appropriately accounted
for as a sales type lease by Easter. The present value at January 1, 2011 of all rent
payments over the lease term discounted at a 10% interest rate was P5,280,000.
What is the gross profit on sale for 2011?
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“SUBSTANCE IS BETTER THAN FORM”…mikecpamicbmba@125487