Lease - Lessee's Perspective: Lecture Notes

Lease – Lessee’s Perspective 2020
LECTURE NOTES
Leases – a contract that conveys the right to use the underlying asset for a period of time in exchange for consideration.
In other words, the lessor conveys the right to use an asset over the lessee for a period of time in exchange for money
or other consideration.
✓ IFRS 16 requires that a lessee initially recognize a right of use asset and a lease liability for the obligation to
make payments. This model is actually called a FINANCE LEASE.
✓ IFRS 16 also permits the lessee to apply the OPERATING LEASE MODEL (meaning no asset, no liability; only
rent expense is recognized) in two optional exemptions:
a) Short-term lease (Lease term of 12 mos. or less)
b) Low value lease (Matter of professional judgement)
Finance Lease – At the commencement date, the lessee shall recognize a right of use asset and a lease liability.
✓ Lease Liability – it should be measured at the PRESENT VALUE OF FUTURE LEASE PAYMENTS using either the
(1st) implicit interest rate or (2nd) incremental borrowing rate.
❖ Components of Future Lease Payments:

a) Fixed Lease Payments;
b) Variable Lease Payments;
c) Purchase Option;
d) Guaranteed Residual Value; and
e) Expected Penalties
** Executory Costs (maintenance, taxes, and insurance) are NOT INCLUDED in the lease
payments. It is expensed immediately.
❖ Components of Right of Use Asset:

✓ Present Value of Future Lease Payments;
✓ Lease payments made LESS any lease incentives received;
✓ Initial Direct Costs
✓ Estimated Dismantling/Removing/Restoring Costs
❖ Formula Form:
Computation of LEASE LIABILITY & RIGHT OF USE ASSET:
Present Value of Future Payments:
Fixed Lease Payments Xxx
Variable Lease Payments xxx
Purchase Option xxx
Residual Value Guarantee xxx
Expected Penalties xxx
Initial carrying amount of Lease Liability xxx
Lease payments made xxx
Lease incentives received (xxx)
Initial direct costs incurred xxx
Estimated Dismantling/Removing/Restoring Costs xxx
Initial carrying amount of Right of Use Asset xxx
❖ Subsequent measurement of Right of Use Asset – Cost Model (Cost less any accumulated depreciation
and impairment loss)
✓ The lessee shall depreciate the ROU asset over what life?
YES Use Asset's Useful Life
Ownership transferred to lessee?
Lessee will buy the asset?
NO Use Lease Term
✓ Actual purchase of leased asset – In cases where the lessee buys the asset during the lease term: the cost of
the asset purchased is equal to the carrying amount of the leased asset plus cash payment minus the balance
of the lease liability. (This is different from the purchase option because this is specifically included in the lease
contract)
FEU – IABF Page 1

APPLICATION
Lease with Executory Costs, Initial Direct Costs, Lease Incentive
PROBLEM 1: On January 1, 2020, Matcha Company closed a lease contract for newly constructed terminals and freight
storage facilities. Although the terminals have a composite life of 10 years, the lease runs for 5 years with a transfer of
title to the lessee upon expiration of the lease.
The annual lease payment is P1,000,000 payable at the end of each year starting December 31, 2020.
The lessee must also make an annual payment of P75,000 for taxes and P125,000 for insurance.
The lessee incurred initial direct cost of P150,000 including P50,000 commission paid to the broker that arranged the
lease. As an incentive to the lessee, the lessor agreed to reimburse the lessee for the commission of P50,000.
The contract was negotiated to assure the lessor a 10% rate of return. The present value of an ordinary annuity of 1 at
10% for five periods is 3.79. The present value of an annuity of 1 in advance at 10% for five periods is 4.17.
Required:
a) How much is the initial carrying amount of the lease liability?
b) How much is the initial carrying amount of the right of use asset?
c) How much is the annual depreciation?
d) How much is the interest expense for 2020 and 2021?
e) Prepare journal entries for 2020 and 2021.
Guidelines:
1st: Compute LEASE LIABILITY & ROU ASSET using the table provided.
2nd: Compute depreciation, if necessary.
3nd: Prepare table of amortization, if necessary.
Solution:
1st: Computation of LEASE LIABILITY & RIGHT OF USE ASSET:
Present Value of:
Fixed Lease Payments (P1M x 3.79*) 3,790,000
Variable Lease Payments -
Purchase Option -
Residual Value Guarantee -
Expected Penalties -
Initial carrying amount of Lease Liability 3,790,000
Lease payments made -
Lease incentives received - 50,000
Initial direct costs incurred 150,000
Estimated Dismantling/Removing/Restoring Costs -
Initial carrying amount of Right of Use Asset 3,890,000
2nd: Annual Depreciation:

Cost / Initial CA of ROU asset 3,890,000
Residual value -
Depreciable amount 3,890,000
Divided by: Useful life** (in years) 10 389,000
*The fixed lease payments are made annually at the end of each period. Hence, ordinary annuity is used.
**Since there is transfer of ownership, we used the useful life of 10 years instead of the lease term of 5 years.
3rd: Amortization table: Attributable to:

Date Payment Interest expense Principal CA
1/1/2020 3,790,000
12/31/2020 1,000,000 379,000 621,000 3,169,000
12/31/2021 1,000,000 316,900 683,100 2,485,900
Annual payment:
Taxes 75,000
Insurance 125,000
Annual Executory Costs (Expensed Immediately) 200,000
JE:
Jan. 1, 2020
Right of Use Asset 3,890,000
Lease liability 3,790,000
Cash 100,000
Dec. 31, 2020

Taxes 75,000
Insurance 125,000
Cash 200,000
Depreciation 389,000
Accumulated depreciation 389,000
FEU – IABF Page 2

Interest expense 416,900

Lease liability 583,100
Cash 1,000,000
Dec. 31, 2021

Taxes 75,000
Insurance 125,000
Cash 200,000

Cash 1,000,000
Lease with Purchase Option Reasonably Expected to be Exercised

Problem 2: On January 1, 2020, Kira Company leased a machine with the following provisions:
Annual lease payment in advance at the beginning of each
year, starting January 1, 2020 1,000,000
Lease term 10 years
Useful life of machine 15 years
Implicit interest rate in the lease 12%
PV of an ordinary annuity of 1 at 12% for 10 periods 5.650
PV of an annuity of 1 in advance at 12% for 10 periods 6.328
PV of 1 at 12% for 10 periods 0.322
The entity has an option to purchase the machine on January 1, 2030 by paying P200,000.
At the commencement date, it is reasonably certain that the purchase option will be exercised.
Required:
d) Prepare a table of amortization.
e) Prepare journal entries for 2020.
f) Assuming the purchase option was not exercised on January 1, 2030, how much is the loss on finance lease?
Guidelines:
Solution:
Present Value of:
Purchase Option (P200k x .322***) 64,400
Lease incentives received -
Initial direct costs incurred -

Residual value -
Divided by: Useful life** (in years) 15 426,160
*The fixed lease payments are made annually at the beginning of each period Hence, annuity in advance is used.
**The purchase option will be paid in a single payment at the end of the lease term. Hence, PVF of 1 is used.
**Since there is reasonable certainty that the asset will be bought, we used the useful life of 15 years instead of the
lease term of 10 years.

1/1/2020 6,392,400
1/1/2020 1,000,000 - 1,000,000 5,392,400
1/1/2021 1,000,000 647,088 352,912 5,039,488
1/1/2022 1,000,000 604,739 395,261 4,644,227
FEU – IABF Page 3

1/1/2023 1,000,000 557,307 442,693 4,201,534

1/1/2024 1,000,000 504,184 495,816 3,705,718
1/1/2025 1,000,000 444,686 555,314 3,150,404
1/1/2026 1,000,000 378,048 621,952 2,528,452
1/1/2027 1,000,000 303,414 696,586 1,831,867
1/1/2028 1,000,000 219,824 780,176 1,051,691
1/1/2029 1,000,000 126,203 873,797 177,894
1/1/2030 200,000 22,106 177,894 -
JE:
Jan. 1, 2020

Cash 1,000,000
Dec. 31, 2020


Interest payable 647,088
Jan. 01, 2021

Cash 1,000,000
Guideline:
If for some reason the purchase option was not exercised, a loss on finance lease shall be recognized for the
difference between:
a) Carrying amount of the ROU Asset; and
b) Carrying amount of the Lease Liability
Solution:
ROU Asset - Cost 6,392,400
Less: Accumulated depreciation:
Annual depreciation 426,160
Used life (years) 10 4,261,600
CA, Jan. 1, 2030 2,130,800
Lease liability, Jan. 1, 2030 200,000
Loss on finance Lease 1,930,800
JE:
Accumulated depreciation 4,261,600
Loss on finance lease 1,930,800
Lease with Purchase Option Not Reasonably Expected to be Exercised

Problem 3: At the beginning of 2020, Wknd Company leased a building with the following information:
Annual fixed payment in advance at the beginning of each lease year 1,000,000
Initial direct cost paid 350,000
Lease incentive received 150,000
Lease bonus paid to lessor before commencement of lease 100,000
Discounted amount of restoring the building as required by contract 200,000
Purchase option that is not reasonbly certain to be exercised 300,000
Lease term 5 years
Useful life of building 8 years
Implicit interest rate 8%
Required:
d) How much is the interest expense for 2020?
Guidelines:
FEU – IABF Page 4

Solution:
Present Value of:
Purchase Option ** -
Initial carrying amount of Lease Liability 4,310, 000
Lease payments made 100,000
Lease incentives received - 150,000
Initial direct costs incurred 350,000
Estimated Dismantling/Removing/Restoring Costs 200,000

Residual value -
Divided by: Useful life*** (in years) 5 962,000
*The fixed lease payments are made annually at the beginning of each period. Hence, annuity in advance is used.
**The purchase option is not reasonably certain to be exercised. Hence, it is not included in the initial carrying amount
of the lease liability.
***Since the purchase option is not expected to be exercised, we used the lease term of 5 years instead of the useful
life of 8 years.

1/1/2020 4,310,000
1/1/2020 1,000,000 - 1,000,000 3,310,000
1/1/2021 1,000,000 264,800 735,200 2,574,800
Lease with Guaranteed Residual Value

Problem 4: On December 31, 2020, Eden Company leased an equipment with the following terms:
Annual rent payable in advance on December 31 of each year 420,000
Estimated residual value at the end of lease term 300,000
Residual value guarantee by lessee 200,000
Lease term 4 years
Economic life of equipment 6 years
Implicit interest rate 7%
Included in the annual rental is an amount of P20,000 to cover reimbursement for insurance paid by the lessor.
The directors of Eden Company have indicated that they intend to return the asset to the lessor at the end of the lease
term.
Required:
d) Prepare an amortization table.
f) Assuming the equipment has a fair value of P50,000, how much is the loss on finance lease?
g) Assuming the equipment has a fair value of P300,000, how much is the loss on finance lease?
Solution:
Present Value of:
Fixed Lease Payments (P400k* x 3.6243**) 1,449,720
Purchase Option -
Residual Value Guarantee (P200k x .7629***) 152,580
FEU – IABF Page 5


Residual value**** 200,000
Divided by: Lease term***** (in years) 4 350,575
*The annual payments of P420,000 include executory costs of P20,000. Such costs must be deducted to get the fixed
lease payments.
**The fixed lease payments are made annually in advance. Hence, annuity in advance is used.
***The guaranteed residual value will be paid in a single payment at the end of the lease term. Hence, PVF of 1 is used.
****The estimated residual value is ignored since there is a guaranteed residual value.
*****Since there will be no transfer of ownership nor purchase option, we used the lease term of 4 years instead of
the economic life of 6 years.

12/31/2020 1,602,300
12/31/2020 400,000 - 400,000 1,202,300
12/31/2021 400,000 84,161 315,839 886,461
12/31/2022 400,000 62,052 337,948 548,513
12/31/2023 400,000 38,396 361,604 186,909
12/31/2024 200,000 13,091 186,909 -
JE:
Dec. 31, 2020

Cash 400,000
Dec. 31, 2021


Cash 400,000
Guidelines:
Upon the end of the lease term, the lessee will return the asset to the lessor:
If the FAIR VALUE > GRV, there is no loss.
If the FAIR VALUE < GRV, there is loss on finance lease equal to the cash settlement.
Solution: (Assumption: Fair value is P50,000)

Fair value, Dec. 31, 2024 50,000
Less: CA of ROU / GRV*:
ROU Asset, cost 1,602,300
Used life (in years) 4
1,402,300 200,000
Loss on finance lease / Cash settlement 150,000
*Actually, the GRV is equal to the CA of the ROU Asset on Dec. 31, 2024
JE: Dec. 31, 2024

ROU 1,602,300
Loss on finance lease 150,000

Cash 150,000
Solution: (Assumption: Fair value is P300,000)

Fair value, Dec. 31, 2024 300,000
Less: CA of ROU / GRV*:
ROU Asset, cost 1,602,300
Used life (in years) 4
1,402,300 200,000
Ignore (Gain is not recognized) 100,000
Loss on finance lease / Cash settlement -
*Actually, the GRV is equal to the CA of the ROU Asset on Dec. 31, 2024
FEU – IABF Page 6

JE:
ROU 1,602,300
Loss on finance lease -

Cash -
Lease with Unguaranteed Residual Value

Problem 5: Dexter Company has maintained a policy of acquiring equipment by leasing. On January 1, 2020, Dexter
Company entered into a lease agreement for an equipment. The lease stipulates an annual rental payment of P600,000
to be paid every December 31 starting December 31, 2020.
The lease contains neither a transfer of title to the lessee nor a purchase option. The equipment has a residual value of
P300,000 at the end of the 5-year lease period but is unguaranteed by the lessee. The economic life of the equipment
is 8 years.
The implicit interest rate is 12% after considering the unguaranteed residual value. The present value of an ordinary
annuity of 1 at 12% for 5 periods is 3.60.
Required:
d) Prepare an amortization table.
f) Assuming the equipment has a fair value of P200,000, how much is the loss on finance lease?
g) Assuming the equipment has a fair value of P400,000, how much is the loss on finance lease?
Guidelines:
Solution:
Present Value of:
Fixed Lease Payments (P600k x 3.60) 2,160,000
Purchase Option -
Residual Value Guarantee * -

Residual value -
Divided by: Lease term** (in years) 5 432,000
*The residual value is not included in the present value of lease payments because it is unguaranteed by the lessee.
**Since there will be no transfer of ownership nor purchase option, we used the lease term of 5 years instead of the
economic life of 8 years.

1/1/2020 2,160,000
12/31/2020 600,000 259,200 340,800 1,819,200
12/31/2021 600,000 218,304 381,696 1,437,504
12/31/2022 600,000 172,500 427,500 1,010,004
12/31/2023 600,000 121,201 478,799 531,205
12/31/2024 600,000 63,745 531,205 -
JE:
Jan. 1, 2020
Dec. 31, 2020
FEU – IABF Page 7


Cash 600,000
Dec. 31, 2021


Cash 600,000
Loss on finance lease*** Nil
***There is no loss in finance lease regardless of whether the fair value of the asset is higher or lower than the
unguaranteed residual value.
***The lessee has no financial obligation but to return the leased asset to the lessor.
JE:
Dec. 31, 2021
Accumulated depreciation (P432k x 5 years) 2,160,000
ROU Asset 2,160,000
To derecognize the asset upon its return to the lessor.
Lease with Unguaranteed Residual Value

Problem 6: On January 1, 2020, Day Company entered into a 10-year lease agreement with Ward Company for
industrial equipment. Annual lease payments of P1,000,000 are payable at the end of each year. Day Company knows
that the lessor expects a 10% return on the lease. The equipment is expected to have an estimated useful life of 10
years.
In addition, a third party has guaranteed to pay Ward a residual value of P500,000 at the end of the lease. The present
value of an ordinary annuity of 1 at 10% for 10 years is 6.14. The present value of 1 at 10% for 10 years is .39.
Required:
d) How much is the interest expense for 2020?
Guidelines:
Solution:
Present Value of:
Fixed Lease Payments (P1M x 6.14) 6,140,000
Purchase Option -
Residual Value Guarantee * -

Residual value -
Divided by: Lease term** (in years) 10 614,000
*The residual value is not included in the present value of lease payments because it is unguaranteed by the lessee.
The lease payments shall include the residual value guarantee if guaranteed by the lessee. In this case, the residual
value is guaranteed by a third party and therefore excluded in computing the lease liability.
**The lease term is equal to the useful life of the equipment at 10 years.
FEU – IABF Page 8


1/1/2020 6,140,000
12/31/2020 1,000,000 614,000 386,000 5,754,000
Lease with Actual Purchase of Leased Asset

Problem 7: Candon Company leased many assets and capitalized most of the leased assets. On December 31, 2020,
the entity had the following balances in relation to a leased equipment:
Right of use asset 4,000,000
Depreciation has been recorded up to the end of the current year and no accrued interest is involved. On December 31,
2020, the entity decided to purchase the equipment for P1,600,000 cash.
Required: What is the cost of the actual purchase of the leased equipment?
Guideline: Actual purchase of leased asset – In cases where the lessee buys the asset during the lease term: the
cost of the asset purchased is equal to the carrying amount of the leased asset plus cash payment minus the balance
of the lease liability. (This is different from the purchase option because this is specifically included in the lease
contract)
Solution:
Computation of Cost of Leased Asset Purchased
CA of leased asset:
Right of use asset 4,000,000
Less: Accumulated depreciation 2,450,000 1,550,000
Add: Cash payment 1,600,000
Total 3,150,000
Less: CA of lease liability 1,300,000
Cost of Equipment 1,850,000
JE:
Dec. 31, 2020
Equipment 1,850,000
Accumulated depreciation - ROU Asset 2,450,000
ROU Asset 4,000,000
Cash 1,600,000
END
FEU – IABF Page 9

Lease - Lessee's Perspective: Lecture Notes

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Lease – Lessee’s Perspective 2020

❖ Components of Future Lease Payments:

❖ Components of Right of Use Asset:

FEU – IABF Page 1

2nd: Annual Depreciation:

3rd: Amortization table: Attributable to:

Dec. 31, 2020

FEU – IABF Page 2

Interest expense 416,900

Dec. 31, 2021

Interest expense 352,759

Lease with Purchase Option Reasonably Expected to be Exercised

2nd: Annual Depreciation:

3rd: Amortization table: Attributable to:

FEU – IABF Page 3

1/1/2023 1,000,000 557,307 442,693 4,201,534

Lease liability 1,000,000

Dec. 31, 2020

Interest expense 647,088

Jan. 01, 2021

Lease with Purchase Option Not Reasonably Expected to be Exercised

FEU – IABF Page 4

2nd: Annual Depreciation:

3rd: Amortization table: Attributable to:

Lease with Guaranteed Residual Value

FEU – IABF Page 5

2nd: Annual Depreciation:

3rd: Amortization table: Attributable to:

Lease liability 400,000

Dec. 31, 2021

Interest expense 84,161

Solution: (Assumption: Fair value is P50,000)

JE: Dec. 31, 2024

Loss on finance lease 150,000

Solution: (Assumption: Fair value is P300,000)

FEU – IABF Page 6

Loss on finance lease -

Lease with Unguaranteed Residual Value

2nd: Annual Depreciation:

3rd: Amortization table: Attributable to:

Dec. 31, 2020

FEU – IABF Page 7

Interest expense 259,200

Dec. 31, 2021

Interest expense 218,304

Loss on finance lease*** Nil

Lease with Unguaranteed Residual Value

2nd: Annual Depreciation:

FEU – IABF Page 8

3rd: Amortization table: Attributable to:

Lease with Actual Purchase of Leased Asset

FEU – IABF Page 9

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