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PRACTICAL ACCOUNTING 1 – REVIEW

LEASES 2019

PROF. U.C. VALLADOLID

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

1. Rapp Co. leased a new machine to Lake Co. on January 1, year 1. The lease is an operating lease and expires on January 1,
year 6. The annual rental is 90,000. Additionally, on January 1, year 1, 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 year 1 income statement, the amount of rental
revenue should be
a. 140,000 b. 125,000 c. 100,000 d. 90,000

2. Wall Co. leased office premises to Fox, Inc. for a five-year term beginning January 2, year 1. Under the terms of the operating
lease, rent for the first year is 8,000 and rent for years two through five is 12,500 per annum. However, as an inducement to
enter the lease, Wall granted Fox the first six months of the lease rent-free. In its December 31, year 1 income statement, what
amount should Wall report as rental income?
a. 12,000 b. 11,600 c. 10,800 d. 8,000

3. On January 1, year 1, 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 year 1, Wren incurred insurance and property tax expense totaling 9,000. Wren’s net rental income for year 1 should
be
a. 27,500 b. 29,000 c. 35,000 d. 36,500

4. Ozz Company, a lessor, leased an equipment under an operating lease. The lease term is 5 years and the lease payments are
made in advance on January 1 of each year as shown in the following schedule:
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January 1, 2017 1,000,000
January 1, 2018 1,000,000
January 1, 2019 1,400,000
January 1, 2020 1,700,000
January 1, 2021 1,900,000
Total rentals 7,000,000

1. What is the rent income for 2017?

a. 1,000,000 b. 1,400,000 c. 2,000,000 d. 1,500,000

2. On December 31, 2018, what amount should be recognized as accrued rent receivable?
a. 700,0000 b.800,000 c.400,000 d. 0

5. On January 1, 2019, an entity leased a building from a lessor with the following pertinent information.
Annual rental payable at the end of each year 1,000,000
Initial direct cost paid 400,000
Lease incentive received 100,000
Leasehold improvement 200,000
Purchase option that is reasonably certain to be exercised 500,000
Lease term 5 years
Useful life of building 8 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
Present value of 1 for 5 periods at 10% 0.62

1. What is the cost of the right of use asset?

a. 4,500,000 b. 4,400,000 c. 4,700,000 d. 4,600,000

2. What is the lease liability on December 31, 2019?

a. 3,510,000 b. 3,169,000 c. 3,950,000 d. 3,719,000
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6. At the beginning of the current year, Joshtin Company leased a machinery with the following information:

Annual rental payable at the end of each year 1,000,000

Residual value guarantee 500,000
Payment to lessor to obtain a long-term lease 300,000
Cost of dismantling and restoring the asset as required
by contract at present value 390,000
Annual executory cost paid by lessee 50,000
Lease term 4 years
Useful life of machinery 8 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 at 10% for 4 periods 3.17
Present value of 1 at 10% for 4 periods 0.68

1. What is the initial lease liability?

a. 3,510,000 b. 3,170,000 c. 4,010,000 d. 4,000,000

2. What is the cost of right use asset?

a. 4,200,000 b. 4,250,000 c. 3,810,000 d. 3,900,000

3. What is the depreciation for current year?

a. 462,500 b. 925,000 c. 850,000 d. 965,000

4. What is the lease liability at year-end?

a. 2,510,000 b. 3,159,000 c. 2,861,000 d. 3,620,000

7. Jerome Company entered into a ten-year noncancelable lease requiring year-end payments of P 1,200,000 on January 01,
2018. The incremental borrowing rate is 15%, while the lessor’s implicit interest rate is 10%. Present value factors for an
ordinary annuity for ten periods are 6.145 at 10% and 5.019 at 15%. An initial direct cost of P 150,000 in negotiating and
securing the leasing arrangement was paid on the same day. Ownership of the property remains with the lessor at expiration of
the lease. There is no purchase option. The leased property has an estimated economic life of 12 years.

1. What amount should be the initial cost of the right of use asset?
a. 7,245,000 b. 7,524,000 c. 7,750,000 d. 6,850,000

2. What amount should be recognized initially as lease liability?

a. 7,245,000 b. 6,145,000 c. 7,345,000 d. 7,374,000

3. What is annual depreciation of the right of use asset?

a. 834,500 b. 614,100 c. 752,400 d. 734,500

8. An entity recorded the cost right of use asset at P4,500,000. The underlying asset had a useful life of 8 years and the lease
term is 5 years. The asset is expected to have a fair value of P1,500,000 at the end of 5 years and a fair value of P500,000 at
the end of 8 years.
The lease agreement provided for the transfer of title of the underlying asset to the lessee at the end of the lease term.

What amount of depreciation expense should be recorded for the first year of the lease
a. 900,000 b. 800,000 c. 600,000 d. 500,000

9. On January 1, 2022, Kaila Company and the lessor agreed to amend the original terms of the lease by reducing the lease
payment to 50,000 and increasing the implicit rate to 9%.

The lease liability has a carrying amount of 200,000 on January 1, 2022.

The present value of an ordinary annuity of 1 at 9% for 3 periods is 2.5313.

What is the decrease or increase in lease liability for 2022?

a. 73,435 increase b. 73,435 decrease c. 50,000 increase d. 50,000 decrease
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10. On January 1, year 1, Babson, Inc. leased two automobiles for executive use. The lease requires Babson to make five annual
payments of 13,000 beginning January 1, year 1. At the end of the lease term, December 31, year 5, Babson guarantees the
residual value of the automobiles will total 10,000. The lease qualifies as a finance lease. The interest rate implicit in the lease
is 9%. Present value factors for the 9% rate implicit in the lease are as follows:
For an annuity due with five payments 4.240 For an ordinary annuity with five payments 3.890 Present value of 1 for five
periods 0.650 Babson’s recorded finance lease liability immediately after the first required payment should be
a. 48,620 b. 44,070 c. 35,620 d. 31,070

11. On December 30, year 1, Rafferty Corp. leased equipment under a finance 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
finance lease obligation was recorded on December 30, year 1, at 135,000, and the first lease payment was made on that date.
What amount should Rafferty include in current liabilities for this finance lease in its December 31, year 1 balance sheet?
a. 6,500 b. 8,500 c. 11,500 d. 20,000

12. On January 2, year 1, Nori Mining Co. (lessee) entered into a five-year lease for drilling equipment. Nori accounted for the
acquisition as a finance lease for 240,000, which includes a 10,000 bargain purchase option. At the end of the lease, Nori
expects to exercise the bargain purchase option. Nori estimates that the equipment’s fair value will be 20,000 at the end of its
eight-year life. Nori regularly uses straight-line depreciation on similar equipment. For the year ended December 31, year 1,
what amount should Nori recognize as depreciation expense on the leased asset?
a. 48,000 b. 46,000 c. 30,000 d. 27,500

13. On January 1, 2019, Mess Company entered to a ten-year non-cancelable lease agreement to lease a building from Keep
Company. The agreement required equal annual payments at the end of each year. The fair value of the building at the
beginning of the lease is P3,949,500, while the carrying amount to Keep Company is P3,458,000. The building has estimated
useful life of 10 years. The title of the building will be transferred to Mess at the end of the lease. The incremental borrowing
rate of Mess Company is 12%. Keep Company set the annual rental to insure 10% rate of return. The implicit rate of the lessor
is known by the lessee. The annual lease payment includes P35,000 executory costs.
1. What is the minimum annual lease payment?
a. 642,718 b. 500,000 c. 562,734 d. 480,000

2. What Is the total annual lease payment?

a. 515,000 b. 535,000 c. 597,734 d. 677,718

14. Angel Company entered into a finance lease on January 1, 2018. The lessee guaranteed the residual value of the asset under
the lease estimated to beP1,200,000 on January 1,2023,the end of the lease term.

Annual lease payments are P1,000,000 due each December 31, beginning December 31,2018.The last payment is due
December 31,2022.

The remaining useful life of the asset was six years at the commencement of the lease.
Both the lessor and the lessee used 10% as the interest rate. The PV of 1 at 10% for 5 periods is .62,and the PV of an ordinary
annuity of 1 at 10% for 5 periods is. 3.79.

1. What is the net lease receivable of the lessor at the commencement of the lease?
a. 4,534,000 b. 3,790,000 c. 4,990,000 d. 2,590,000

2. What is the gross investment in the lease?

a. 5,000,000 b. 6,2000,000 c. 3,800,000 d. 5,744,000

3. What is the total unearned interest income?

a. 2,410,000 b. 1,666,000 c. 1,210,000 d. 466,000

4. What is the interest income for 2018?

a. 379,000 b. 620,000 c. 453,400 d. 500,000
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15. An entity is a dealer in equipment and uses leases to facilitate the sale of its product. The entity expects a 12% return. At the
end of the lease term, the equipment will revert to the lessor.

On January 1, 2019, an equipment is leased to a lessee with the following information:

Cost of equipment to the entity 3,500,000

Fair value of equipment 5,500,000
Residual value – unguaranteed 600,000
Initial direct cost 200,000
Annual rental payable in advance 900,000
Useful life and lease term 8 years
Implicit interest rate 12%
PV of 1 at 12% for 8 periods 0.40
PV of an ordinary annuity of 1 at 12% for 8 periods 4.97
PV of an annuity due of 1 at 12% for 8 periods 5.56
First lease payment January 1, 2019

1. What is the gross investment in the lease?

a. 7,800,000 b. 7,200,000 c. 6,600,000 d. 6,900,000

2. What is the net investment in the lease?

a. 5,004,000 b. 5,244,000 c. 5,500,000 d. 5,740,000

3. What is the total financial revenue?

a. 2,196,000 b. 2,796,000 c. 2,556,000 d. 1,956,000

4. What amount should be recognized as interest income for 2019?

a. 600,480 b. 492,480 c. 536,760 d. 521,280

5. What amount of cost of goods sold should be recognized in recording the lease?
a. 3,260,000 b. 3,500,000 c. 3,740,000 d. 3,460,000

Sale and leaseback (IFRS 16)

1. At year-end, Bain Company sold a machine with 12-year useful life to another entity and simultaneously leased it
back for one year.

Sale price 360,000

Carrying amount 330,000
Present value of reasonable lease rentals
(3,000 for 12 months @ 12%) 34,100

What amount of gain on right transferred should be reported in the current year?
a. 34,100 b. 30,000 c. 4,100 d. 0
2. At the beginning of current year, East Company sold an equipment with remaining life of 10 years and
immediately leased it back for 4 years at the prevailing market rental.

Sale price at fair value 6,000,000

Carrying amount of equipment 4,500,000
Annual rental payable at the end of each year 800,000
Implicit interest rate 10%
Present value of an ordinary annuity of 1 at 10% for
Four periods 3.17

1. What is the initial lease liability?

a. 2,536,000 b. 3,200,000 c. 3,000,000 d. 0

2. What is the cost of right of use asset?

a. 1,902,000 b. 2,598,000 c. 2,536,000 d. 0
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3. What is the gain on right transferred to the buyer-lessor?

a. 866,000 b. 634,000 c. 750,000 d. 0

4. What is the annual depreciation of the right of use asset?

a. 475,500 b. 190,200 c. 634,000 d. 253,600

5. What is the net annual rental income of the buyer-lessor?

a. 800,000 b. 200,000 c. 600,000 d. 400,000

3. At the beginning of current year, Simple Company sold a building with remaining life of 20 years and immediately
leased it back for 5 years.

Sale price at above fair value 20,000,000

Fair value of building 18,000,000
Carrying amount of building 10,800,000
Annual rental payable at the end of each year 1.500,000
Implicit interest rate 12%
Present value of an ordinary annuity of 1 at 12%
For five periods 3.60

1. What is the initial lease liability?

a. 5,400,000 b. 3,400,000 c. 7,500,000 d. 7,400,000

2. What is the cost of right of use asset?

a. 2,040,000 b. 4,000,000 c. 2,000,000 d. 3,000,000

3. What is the gain on right transferred to the buyer-lessor?

a. 7,200,000 b. 1,500,000 c. 5,600,000 d. 5,840,000

4. What is the gross rental income of the buyer-lessor?

a. 1,500,000 b. 2,000,000 c. 944,444 d. 555,596

5. What is the depreciation of the building of the buyer-lessor?

a. 1,000,000 b. 1,500,000 c. 900,000 d. 500,000
4. At the beginning of current year, Hazel Company sold a machine and immediately leased it back. The following
data pertain to the sale and leaseback transaction:

Sale price at below fair value 4,000,000

Fair value of machine 4,500,000
Carrying amount of machine 3,600,000
Annual rental payable at the end of each year 500,000
Remaining life of machine 10 years
Lease term 3 years
Implicit interest rate 6%
Present value of an ordinary annuity of 1 at 6%
For 3 periods 2.67

1. What is the initial lease liability?

a. 1,335,000 b. 1,500,000 c. 4,000,000 d. 5,000,000

2. What is the cost of right of use asset?

a. 3,600,000 b. 1,468,000 c. 1,800,000 d. 2,880,000

3. What is the gain transferred to the buyer-lessor?

a. 900,000 b. 720,000 c. 533,000 d. 500,000

4. What is the net annual rent income of the buyer-lessor?

a. 500,000 b. 150,000 c. 250,000 d. 100,000
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5. At the beginning of current year, World Company sold a machine with useful life of 20 years and immediately
leased it back for 5 years. The following data pertain to the sale and leaseback transaction:

Sale price at fair value 5,000,000

Carrying amount of machine 6,000,000
Annual rental payable at the end of the year 500,000
Implicit interest rate 6%
Present value of an ordinary annuity of 1 at
6% for 5 periods 4.21

1. What is the initial lease liability

a. 2,500,000 b. 2,105,000 c. 3,000,000 d. 0

2. What is the cost of right of use asset?

a. 2,105,000 b. 2,526,000 c. 2,895,000 d. 1,500,000

3. What is the loss on right transferred to the buyer-lessor?

a. 508,200 b. 500,000 c. 579,000 d. 0

4. What is the net annual rent income of the buyer-lessor?

a. 373,700 b. 200,000 c. 500,000 d. 250,000
6. At the beginning of current year, Judy Company sold a building with remaining useful life of 30 years and
immediately leased it back for 5 years.

Sale price at below fair value 18,000,000

Fair value of building 20,000,000
Carrying amount of building 24,000,000
Annual rental payable at the end of each year 1,000,000
Implicit interest rate 12%
Present value of an ordinary annuity of 1 at 12%
For 5 periods 3.60

1. What is the initial lease liability?

a. 3,600,000 b. 4,000,000 c. 4,800,000 d. 0
2. What is the cost of right of use of asset?
a. 3,000,000 b. 2,880,000 c. 5,760,000 d. 6,720,000
3. What is the loss on right transferred?
a. 4,000,000 b. 2,880,000 c. 4,320,000 d. 6,000,000
4. What is the net annual rent income of the buyer-lessor?
a. 400,000 b. 200,000 c. 300,000 d. 100,000

Sale and leaseback

Answer Section
1. ANS:
B
Sale price 360,000
Carrying amount 330,000
Gain on right transferred 30,000

IFRS 16, paragraph 5, provides that a lessee is permitted to make an accounting policy election to apply
the operating lease model if the lease is short-term or if the underlying asset is of low value.

A short-term is a lease that has a term of twelve months or less at the commencement date.

2. ANS:
1.A
Initial lease liability (800,000 x 3.17) 2,536,000

2.A
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ROUA = C.A. of asset x lease liability(adj)

F.V. of Asset
(2,536,000 / 6,000,000 x 4,500,000) 1,902,000

The cost of right of use asset is equal to a fraction whose numerator is the initial lease liability and whose
denominator is the fair value of the asset multiplied by the carrying amount of the asset.

3. A
Selling Price = Fair Value

Fair value or sale price 6,000,000

Carrying amount 4,500,000
Total gain on sale 1,500,000

Fair value 6,000,000

Right retained by seller-lessee equal to lease liability (2,536,000)
Right transferred to buyer-lessor 3,464,000

Recog gain = Total gain X Rights transferred to buyer

FV of Asset
Gain to be recognized (3,464,000 / 6,000,000 x 1,500,000) 866,000

The gain or loss on right transferred is equal to a fraction whose numerator is the right transferred to the
buyer-lessor and whose denominator is the fair value of the asset multiplied by the total gain or loss on
sale.

The right transferred to the buyer-lessor is equal to the fair value of the asset minus the initial lease
liability.

4. A
Depreciation of right of use asset (1,902,000 / 4) 475,500

5. B
Annual rental 800,000
Depreciation of equipment purchased
(6,000,000 / 10 years) (600,000)
Net rental income of buyer-lessor 200,000

The buyer-lessor shall apply the operating lease model because the lease term of 4 years is only 40% of the
useful life of the asset.

3. ANS:

1. A
Initial lease liability (1,500,000 x 3.60) 5,400,000

2. A
Selling Price > Fair Value
Note: Excess Selling Price is an adjustment (deducted) to lease liability.

Sale price 20,000,000

Fair value 18,000,000
Excess sale price – additional financing 2,000,000

Present value of rentals 5,400,000

Excess SP over FV- additional financing (2,000,000)
Present value related to lease liability 3,400,000
Note: Excess Selling Price is an adjustment (deducted) to lease liability.

ROUA = CA of ASSET X Lease liab(net)

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FV of ASSET
Cost of right of use asset
(3,400,000 / 18,000,000 x 10,800,000) 2,040,000

IFRS 16, paragraph 101, provides that if the sale price does not equal the fair value of the underlying asset,
the seller-lessee shall make adjustment to measure the sale price at fair value.

Any excess sale price over fair value shall be accounted for us additional financing provided by the buyer-
lessor to seller-lessee.

3. D
Fair value 18,000,000
Carrying amount (10,800,000)
Total gain on sale 7,200,000

Fair value 18,000,000

Right retained by seller-lessee equal to lease liability ( 3,400,000)
Right transferred to buyer-lessor 14,600,000

Recog. gain = Total Gain x Rights transferred to buyer/lessor

F.V. of Asset
Gain to be recognized
(14,600,000 / 18,000,000 x 7,200,000) 5,840,000

4. A
Gross Rental Income
Present value Fraction Allocation
Rental income 3,400,000 34/54 x 1.5 944,444
Financial Asset 2,000,000 20/54 x 1.5 555,556
Total present value(MLP) 5,400,000 1,500,000

5. C
Depreciation of building of buyer-lessor
(18,000,000 / 20 years) 900,000

4. ANS:
1. A
Initial lease liability (500,000 x 2.67) 1,335,000

2. B

Fair Value > Selling Price

Note: The excess FV is an adjustment(added) to lease liability.

Fair Value 4,500,000

Sale price 4,000,000
Excess fair value – prepayment of rental 500,000

Initial lease liability 1,335,000

Excess fair value – prepayment of rental 500,000
Total lease liability 1,835,000
Note: The excess FV is an adjustment (added) to lease liability.

ROUA = CA of Asset x lease liab(adj) / FV of Asset

Cost of right of use asset
(1,835,000 / 4,500,000 x 3,600,000) 1,468,000

3. C
Fair value 4,500,000
Carrying amount 3,600,000
Total gain on sale 900,000
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Fair value 4,500,000

Right retained by seller-lessee equal to lease liability 1,835,000
Right transferred to buyer-lessor 2,665,000

Recog. Gain = Rights transferred to lessor/FV of Asset x Gain

Gain to be recognized (2,665,000 / 4,500,000 x 900,000) 533,000

4. D
Annual rental 500,000
Depreciation of machine of buyer-lessor
(4,000,000 / 10 years) (400,000)
Net annual rental income 100,000

Note: 1. excess FV over SP is added to leased liab

2. excess SP over FV is deducted to lease liab

5. ANS: SP = FV
1. B
Initial lease liability (500,000 x 4.21) 2,105,000

2. B
ROUA = Lease liab. / FV of Asset x CA of Asset
Cost of right of use asset
(2,105,000 / 5,000,000 x 6,000,000) 2,526,000

3. C
Sale price 5,000,000
Carrying amount 6,000,000
Total loss on sale (1,000,000)

Fair value 5,000,000

Right retained by seller-lessee equal to lease liability 2,105,000
Right transferred to buyer-lessor 2,895,000

Recog. loss = Rights transferred to lessor / FV of Asset x Total loss

(2,895,000 / 5,000,000 x 1,000,000) 579,000

4. D
Depreciation of machine of buyer-lessor
(5,000,000 / 20 years) 250,000

Annual rent income 500,000

Depreciation of buyer-lessor (250,000)
Net annual rent income 250,000

6. ANS: FV > SP

1. A
Initial lease liability (1,000,000 x 3.60) 3,600,000

2. D
Initial lease liability 3,600,000
Excess fair value (20,000,000 – 18,000,000) 2,000,000
Total lease liability 5,600,000
note: excess FV over SP is added to lease liab

ROUA = Lease liab(adj) / FV of Asset x CA of Asset

Cost of right of use asset
(5,600,000 / 20,000,000 x 24,000,000) 6,720,000

3. B
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Fair value of building 20,000,000

Carrying amount 24,000,000
Total loss (4,000,000)

Fair value of building 20,000,000

Right retained equal to total lease liability ( 5,600,000)
Right transferred to buyer-lessor 14,400,000

Recog. loss = Rights transferred to lessor / FV of Asset x Total loss

(14,400,000 / 20,000,000 x 4,000,000) 2,880,000

4. A
Annual rent income 1,000,000
Depreciation of buyer-lessor (18,000,000 / 30 years) ( 600,000)
Net annual rent income 400,000

Notes to leaseback:

Annual Rental x A1 = Lease liability

Present value of rentals xx

Excess SP over FV- additional financing (xx)
Lease liability(adj) xx
Note: Excess Selling Price is an adjustment (deducted) to lease liability.

Initial lease liability xx

Excess fair value over SP - prepayments xx
Lease liability(adj) xx
note: excess FV over SP is added to lease liab

Lease liab. = Rights retained by seller/lessee

ROUA = CA of ASSET X Lease liab(net)
FV of ASSET
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Fair value of Asset xx

Carrying amount (xx)
Total gain on sale xx
Note: SP is adjusted to FV

Fair value of Asset xx

Right retained by seller-lessee equal to lease liability (xx)
Right transferred to buyer-lessor xx

Recog. Gain(loss) = Total Gain(loss) x Rights transferred to buyer/lessor

F.V. of Asset