MODULE-LEASES

 Lessee Accounting
IFRS 16 is the new lease standard.
A lease is defined as a contract or part of a contract that conveys the right to use the underlying
asset for a period of time in exchange for consideration.
Right to control the use of an asset
a. Obtain substantially all of the economic benefits from the use of the identified asset
b. Direct use of the identified asset
IFRS 16, paragraph 22, provides that at the commencement date, a lessee shall recognize a right of
use asset and a lease liability.

Note: All leases shall be accounted for by the lessee as a finance lease under the new lease standard
Right of Use Asset (ROU)- right to use the underlying asset over the lease term.
Lease Liability (LL)- obligation to make payments over the lease term.
Underlying Asset- subject of the lease.
Lessee-obtains the right to use the underlying asset.
Lessor-provides the right to use the underlying asset.

Operating lease model for lessee

IFRS 16, par. 5, provides that a lessee is permitted to make an accounting policy election to apply the
operating lease accounting and not recognize an asset and lease liability in two optional exemptions.
a. Short-term lease
b. Low value lease
-a lessee may or may not apply the operating lease accounting if the lease is short-term or low value.

-the Operating Lease (OL), the periodic rental is recognized as rent expense using the straight line
basis over the lease term or another systematic basis.

Short term lease- 12 months or less at the commencement date of the lease. A lease that contains a
purchase option is not a short-term lease.

Low value lease- the new lease standard does not provide for a quantitative threshold for low value
asset. It is a matter of professional judgment. A lessee shall assess the value of the asset when it is
new regardless of the age of the asset being used.

Ex., a lease of car would not qualify as low value lease because a new car would typically not be of
low value.

IFRS16, par. 8, provides the election for low value lease on a lease by lease basis.

Finance lease-Lessee

Finance lease- is defined as a lease that transfers substantially all of the risks and rewards incidental
to ownership of an underlying asset.

At the commencement date, the lessee shall recognize a right of use (ROU) and lease liability (LL).

Initial measurement of ROU

IFRS16, par. 23, shall measure the ROU at Cost

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Par. 24, ROU comprises:

a. The amount of initial measurement of the lease liability or the present value of lease
payments
b. Lease payments made to lessor at or before commencement date, such as lease bonus, less
any lease incentives received
c. Initial direct costs incurred by the lessee
d. Estimate of cost of dismantling, removing and restoring the underlying asset for which the
lessee has a present obligation.
Lease incentives are payments by the lessor to the lessee associated with a lease or the
reimbursement or assumption by the lessor of the costs of the lessee. Ex. The lessor agrees to
reimburse the lessee for the commission paid by the lessee to a broker.

Initial direct costs are incremental costs of obtaining a lease that would not have been incurred if
the lease had not been obtained.

Leasehold improvements are not initial direct costs and not included in the cost of ROU. These are
separately accounted for in the PPE and depreciated over the shorter between the lease term and
the life of the improvements.

Security deposit refundable-upon the lease expiration is accounted for as an asset by the lessee.

Subsequent measurement of ROU

-cost model (cost less accumulated depreciation and impairment loss)

-the carrying amount of the ROU is adjusted for any remeasurement of the lease liability.

Presentation of ROU-separate line item in the statement of financial position. As an alternative, the
lessee may include it under the PPE with appropriate disclosure.

Other measurement models

a. Fair value model-investment property
b. Revaluation model- PPE
Depreciation of ROU

IFRS 16, par. 32, provides that the lessee shall depreciate the ROU over the useful life of the
underlying asset under the following conditions:
a. The lease transfers ownership of the underlying asset to the lessee at the end of the lease
term.
b. The lessee is reasonably certain to exercise a purchase option.

Note: In the absence of either of the two options, depreciate the ROU over the shorter between the
useful life of the asset and the lease term.

Measurement of lease liability

IFRS 16, par. 26, provides that at the commencement date, the lessee shall measure the lease
liability at the present value of lease payments.
Interest rate implicit in the lease- the rate use in the lease.
Lessee’s Incremental borrowing rate- will be used in the absence of the implicit rate.

Components of lease payments

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 a. Fixed lease payments less any lease incentives
b. Variable lease payments
c. Exercise price of a purchase option if the lessee is reasonably certain to exercise the option
d. Amount expected to be payable by the lessee under a residual value guarantee
e. Termination penalties if the lease term reflects the exercise of a termination option

Other definitions
Residual value guarantee is the guarantee made to the lessor by a party unrelated to the lessor.
Unguaranteed residual value is that portion of the residual value of the underlying asset, the
realization of the lessor is not assured or is guaranteed solely by a party related to the lessor.
Executory costs are expensed immediately when incurred such as maintenance, taxes and insurance
of the underlying asset.

A Lease term is noncancelable if the lessee is reasonably certain to exercise the extension option or
not to exercise the termination option.

Illustration-Certain purchase option

Isaiah Company lease a machine on January 1, 2019 with the following pertinent information:

Fixed rental payment at the end of each year 1,000,000

Lease term 10 years
Useful life of machine 12 years
Incremental borrowing rate 14%
Implicit borrowing rate 12%
PV of an ordinary annuity of 1 for 10 periods at
14% 5.216
12% 5.650
PV of 1 for 10 periods at
14% 0.270
12% 0.322
Isaiah Company has the option to purchase the machine upon the lease expiration on January 1,
2029 by paying P500,000. The lessee is reasonably certain to exercise the purchase option at the
commencement date of the lease.

The estimated residual value of the machine at the end of the 12-year life is P600,000.

PV of lease payments (1,000,000 x 5.65) 5,560,000

PV of purchase option (500,000 x .322) 161,000
Total lease liability 5,811,000

Journal entries for 2019

1. To record the acquisition of the machinery under a finance lease
Right of use asset 5,811,000
Lease liability 5,811,000

2. To record the first annual rental payment on Dec. 31, 2019:

Interest expense 697,320
Lease liability 302,680
Cash 1,000,000

3. To record the annual depreciation:

Depreciation 434,250

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 Accumulated depreciation 434,250
(5,811,000-600,000 RV/12 years*)

Note: 12 years useful life will be used as the basis for depreciating the ROU because thelessee is
reasonably certain to exercise the purchase option.

Amortization Table
Date Payment Interest Principal Present value
1/1/2019 5,811,000
12/31/2019 1,000,000 697,320 302,680 5,508,320
12/31/2020 1,000,000 660,998 339,002 5,169,318
12/31/2021 1,000,000 620,318 379,682 4,789,636
12/31/2022 1,000,000 574,756 425,244 4,364,392
12/31/2023 1,000,000 523,727 476,273 3,888,119
12/31/2024 1,000,000 466,574 533,426 3,354,694
12/31/2025 1,000,000 402,563 597,437 2,757,257
12/31/2026 1,000,000 330,871 669,129 2,088,128
12/31/2027 1,000,000 250,575 749,425 1,338,703
12/31/2028 1,000,000 161,297 838,703 500,000

Exercise of the purchase option (January 1, 2029)

Lease liability 500,000
Cash 500,000

Nonexercise of purchase option (January 1, 2029)

Accumulated depreciation 4,342,500
Lease liability 500,000
Loss on finance lease 968,500
Right of use asset 5,811,000

Illustration-Residual value guarantee

Paul Company leased an equipment on January 1, 2019 with the following information:

Fixed annual payment at the end of each lease year 1,000,000

Lease term 4 years
Useful life of equipment 5 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 4 periods at 10% 3.16987
PV of 1 for 4 periods at 10% 0.683

Paul Company has guaranteed a P200,000 residual value on December 31, 2022 to the lessor.

Note: As long as there is a residual value guarantee, there is no more purchase option (vice versa)
because the equipment will revert to the lessor upon the expiration of the lease on Dec. 31, 2022.

PV of lease payments (1,000,000 x 3.16987) 3,169,870

PV of residual value guarantee (200,000 x 0.683) 136,600
Cost of ROU and LL 3,306,470

Amortization Table
Date Payment Interest Principal Present value
1/1/2019 3,306,470
12/31/2019 1,000,000 330,647 669,353 2,637,117

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 12/31/2020 1,000,000 263,711 736,289 1,900,828
12/31/2021 1,000,000 190,082 809,918 1,090,910
12/31/2022 1,000,000 109,090 890,910 200,000

Journal entries
1. To record the acquisition of the equipment
Right of use asset 3,306,470
Lease liability 3,306,470

2. To record the first annual rental payment on Dec. 31, 2019:

Interest expense 330,647
Lease liability 669,353
Cash 1,000,000

3. To record the annual depreciation:

Depreciation 776,617
Accumulated depreciation 776,617

Note: The asset is depreciated over the lease term of 4 years which is shorter than the useful life
because there is neither transfer of ownership or purchase option.

Return of equipment to lessor on December 31, 2022

1. To record the final annual payment on December 31, 2022:
Interest expense 109,090
Lease liability 890,910
Cash 1,000,000

2. To record the return of the equipment to the lessor:

Accumulated depreciation *3,106,470
Lease liability 200,000
Right of use asset 3,306,470
*Accu. Depreciation 3,106,468 (adjusted to 3,106,470)

If the FV of the underlying asset is less than the residual value guarantee, a loss is reported for the
difference and the lessee must make up for the difference with a cash payment.

Ex. FV is of the equipment on December 31, 2022 is only P150,000 which is P50,000 lower than the
residual value guarantee

Loss on finance lease 50,000

Cash 50,000

Note:If the FV is higher than the RVG, no additional entry because there is no cash settlement.

Illustration-Initial Direct Cost

Emmanuel Company leased an equipment on January 1, 2019 with the following information:
Annual fixed payment in advance at the beginning of each lease year 1,000,000
Initial direct cost paid on January 1, 2019 250,000
Lease incentive received 150,000
Residual value guarantee 300,000
Lease term 5 years
Useful life of equipment 6 years
Implicit interest rate 8%
PV of an ordinary annuity of 1 in advance at 8% for 5 periods 4.3121

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 PV of 1 at 8% for 5 periods 0.6806

PV of rentals (1,000,000 x 4.3121) 4,312,100

PV of residual value guarantee (300,000 x .6806) 204,180
Lease liability-January 1, 2019 4,516,280
Initial direct cost 250,000
Lease incentive received (150,000)
Cost of ROU 4,616,280

Date Payment Interest Principal Present value

1/1/2019 4,516,280
1/1/2019 1,000,000 1,000,000 3,516,280
1/1/2020 1,000,000 281,302 718,698 2,797,582
1/1/2021 1,000,000 223,807 776,193 2,021,389
1/1/2022 1,000,000 161,711 838,289 1,183,100
1/1/2023 1,000,000 94,648 905,352 277,748
1/1/2024 300,000 *22,252 277,748 -
*adjusted

Journal Entries (2019)

1. To record the acquisition of the equipment under a finance lease:
Right of use asset 4,616,280
Lease liability 4,516,280
Cash (250,000-150,000) 100,000

2. To record the first annual payment on January 1, 2019:

Lease liability 1,000,000
Cash 1,000,000

3. To record the interest for 2019 (Dec 31, 2019)

Interest expense 281,302
Accrued interest payable 281,302

4. To record the depreciation for 2019:

Depreciation (4,316,280/5) 863,256
Accumulated depreciation 863,256
(4,616,280-300,000RV/5 years Lease Term)

Journal Entries (2020)

1. To record the second payment on January 1, 2020:
Accrued interest payable 281,302
Lease liability 718,698
Cash 1,000,000

2. To record the interest for 2020 (Dec 31, 2020)

Interest expense 223,807
Accrued interest payable 223,807

3. To record the depreciation for 2020:

Depreciation (4,316,280/5) 863,256
Accumulated depreciation 863,256

Return of the equipment by the lessee (January 1, 2024):

If the FV of the asset is P400,000 which is higher than the RVG of P300,000, the entry to record the
return of the equipment to the lessor is :

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 Accumulated depreciation (863,256 x 5) 4,316,280
Lease liability 277,748
Accrued interest payable 22,252
Right of use asset 4,616,280

Illustration-Unguaranteed residual value

Aralmuna Company leased a warehouse on January 1, 2019 with the following information:

Annual rental payable at the end of each year 600,000

Unguaranteed residual value 200,000
Payment to lessor to obtain a long-term lease(lease bonus) 224,000
Cost of restoring the asset as required by contract 400,000
Annual executory cost paid 50,000
Lease term 6 years
Useful life of equipment 8 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 6 periods 4.36
PV of 1 at 10% for 6 periods 0.56

The lease provides for neither a transfer of title to the lessee nor a purchase option.

Lease liability (600,000 x 4.36) 2,616,000

Payment to lessor to obtain lease 224,000
Estimated restoration cost 400,000
Total cost of ROU 3,240,000

Note: Unguaranteed RV is not included in the computation of Lease Liability.

Annual executory cost is treated as outright expense.

Journal Entries (2019)

1. To record the acquisition of the warehouse under a finance lease:
Right of use asset 3,240,000
Lease liability 2,616,000
Cash 224,000
Estimated liability for restoration 400,000

2. To record the payment of executory cost:

Executory cost 50,000
Cash 50,000

3. To record the first rental payment on Dec 31, 2019:

Interest expense (10% x 2,616,000) 261,600
Lease liability 338,400
Cash 600,000

4. To record the depreciation for 2019:

Depreciation (3,240,000/6) 540,000
Accumulated depreciation 540,000

-the unguaranteed residual value is ignored in computing the depreciable amount.

Return of equipment to lessor (On January 1, 2025)

Accumulated depreciation (540,000 x 6) 3,240,000
Equipment 3,240,000

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*the lessee has no financial obligation but to return the asset to the lessor.

Illustration-Extension option
Papasa Company entered into a lease of building on January 1, 2019 with the ffg. Information:

Annual rental payable at the end of each year 500,000

Lease term 5 years
Useful life of building 20 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 5 periods 3.791

The lease contained an option for the lessee to extend for a further 5 years. At the commencement
date, the exercise of the extension option is not reasonably certain.
After 3 years, on January 1, 2022 the lessee decided to extend the lease for a further 5 years.

New annual rental payable at the end of each year 600,000

New implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for 5 periods 3.993
PV of 1 at 8% for 2 periods 0.857
PV of an ordinary annuity of 1 at 8% for 2 periods 1.783

Paymen Interes Princip Present

Date
t t al value
1/1/2019 1,895,500
12/31/201 189,55
500,000 310,450 1,585,050
9 0
12/31/202 158,50
500,000 341,495 1,243,555
0 5
12/31/202 124,35
500,000 375,645 867,910
1 5

Remeasurement of lease liability

On January 1, 2022, the lease liability is remeasured using the new implicit interest rate of 8%.
Annual rental for remaining 2 years of old lease term 500,000
Multiply by PV of an OA of 1 at 8% for 2 periods 1.783
PV-January 1, 2022 891,500
Annual rental for 5 years starting January 1, 2024 600,000
Multiply by PV of an OA of 1 at 8% for 5 periods 3.993
PV-January 1, 2024 2,395,800
Multiply by PV of 1 at 7% for 2 periods 0.857
PV-January 1, 2022 2,053,200

The PV of the new rentals on January 1, 2024 is rediscounted for 2 periods on the date of extension
on January 1, 2022.
PV of remaining rentals of old lease term 891,500
PV of rentals of extended lease term 2,053,200
Total PV-January 1, 2022 2,944,700
PV- December 31, 2021 (867,910)
Increase in LL on January 1, 2022 2,076,790
ROU-January 1, 2019 1,895,500
Accu. Depn-December 31, 2021 (379,100x 3 yrs) (1,137,300)

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 Carrying amount-December 31, 2021 758,200
Increase in liability on January 1, 2022 2,076,790
New CA-January 1, 2022 2,834,990

Date Payment Interest Principal Present value

1/1/2022 2,944,700
To record the
12/31/2022 500,000 235,576 264,424 2,680,276
remeasurement of
12/31/2023 500,000 214,422 285,578 2,394,698 the lease liability on
12/31/2024 600,000 191,576 408,424 1,986,274 January 1, 2022:
12/31/2025 600,000 158,902 441,098 1,545,176 ROU
12/31/2026 600,000 123,614 476,386 1,068,790 2,076,790
12/31/2027 600,000 85,503 514,497 554,293 LL
12/31/2028 600,000 45,707* 554,293 2,076790

To record the annual rental on December 31, 2022:

Interest Expense 235,576
LL 264,424
Cash 500,000

To record the annual depreciation based on the new carrying amount

Depreciation 404,999
Accu. Depreciation 404,999
(2,834,990/7 yrs)

Illustration-Variable payments
On January 1, 2019, Quota Company entered into an 8-year lease of a floor of a building with the
following terms:
Annual rental for the first three years payable at the end of each year 300,000
Annual rental for the next five years payable at the end of each year 400,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for three periods 2.487
PV of an ordinary annuity of 1 at 10% for five periods 3.791
PV of 1 at 10% for three periods 0.751

The lease provides for neither a transfer of title to the lessee nor a purchase option.
Annual rental for first 3 years 300,000
Multiply by PV of an ordinary annuity of 1 at 10% for 3 periods 2.487
PV-January 1, 2019 746,100

Annual rental for next 5 periods 400,000

Multiply by PV of an ordinary annuity of 1 at 10% for 5 periods 3.791
PV-January 1, 2022 1,516,400
Multiply by PV of 1 at 10% for 3 periods 0.751
PV-January 1, 2019 1,138,816

PV of annual rentals for 3 years 746,100

PV of annual rentals for next 5 years 1,138,816
LL-January 1, 2019 1,884,916

Date Payment Interest Principal Present value

1/1/2019 1,884,916

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 12/31/2019 300,000 188,492 111,508 1,773,408
12/31/2020 300,000 177,341 122,659 1,650,749
12/31/2021 300,000 165,075 134,925 1,515,824
12/31/2022 400,000 151,582 248,418 1,267,406
12/31/2023 400,000 126,741 273,259 994,147
12/31/2024 400,000 99,415 300,585 693,562
12/31/2025 400,000 69,356 330,644 362,918
12/31/2026 400,000 37,082 * 362,918 -

Actual purchase of underlying asset

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.

Illustration:
JHS Company purchased a building that it had been leasing under a finance lease for P4,000,000. The
balances of certain accounts on the date of actual purchase are as follows:

ROU 5,000,000
Accumulated depreciation 1,500,000
Lease liability 3,800,000

Journal Entry(3.7m=(5m-1.5m)+4m-3.8m)
Building 3,700,000
Accu. Depn 1,500,000
LL 3,800,000
ROU 5,000,000
Cash 4,000,000

Additional Illustration:
A-At the beginning of the current year, an entity leased a building from a lessor with the following
pertinent information:

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

Initial direct cost paid 400,000
Lease bonus paid to lessor before commencement of the lease 300,000
Lease incentive received 100,000
Discounted amount of restoring building as required by contract 700,000
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 0.10
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
0.62
Present value of 1 for 5 periods at 10%
1. What is the initial lease liability? 4,100,000
PV of rentals (1,000,000 x 3.79) 3,790,000
PV of PO (500k x 0.62) 310,000
4,100,000

2. What is the cost of the right of use asset? 5,400,000

Initial lease liability 4,100,000
IDC 400,000

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 LB 300,000
LI (100,000)
Restoration cost 700,000
5,400,000

3. What is the interest expense for the current year? 410,000

Date Payment Interest 10% Principal Present Value
4,100,000
CY 1,000,000 410,000 590,000 3,510,000

4. What is the lease liability at year-end? 3,510,000

5. What is the depreciation of the right of use asset for current year? 675,000
5,400,000/8 yrs=675,000

B-On December 31, 2019, an entity leased two automobiles for executive use. The lease required the
entity to make five annual payments of P1,500,000 beginning December 31, 2019. At the end of the
lease term, December 31, 2024, the entity had a residual value guarantee of the automobiles at
P1,000,000. The interest rate implicit in the lease is 10% and present value factors at 10% for 5
periods are 4.17 for an annuity due, 3.79 for an ordinary annuity and 0.62 for present value of 1.

1. What is the lease liability on December 31, 2020? 4,412,500

2. What is the current portion of the lease liability on December 31, 2020? 1,058,750
3. What is the interest expense for 2020? 537,500

Annual Rental 1,500,000 x 4.17 6,225,000

RV Guarantee 1,000,000 x 0.62 620,000
6,875,000

Date Payment Int 10% Principal PV or CA

12/31/19 6,875,000
12/31/19 1,500,000 1,500,000 5,375,000
12/31/20 1,500,000 537500 (3) 962,500 4412500 (1)
12/31/21 1,500,000 441,250 1,058,750 (2) 3,353,750

C-On January 1, 2019, Entity A enters into a 3-year lease of a group of office furniture with similar
nature. Entity A assesses that the lease is a lease of an underlying asset of low value and elects to
apply the recognition exemptions of PFRS 16. The annual lease payments, payable at the end of each
year, are as follows:

2019 8,000 2020 12,000 2021 14,000

As an inducement to enter to the lease, the lessor granted Customer A the first six months of the
lease as rent-free.

1. Compute the annual rent expense? 10,000

2019 (8k x 6/12) 4,000
2020 12,000
2021 14,000
Total lease payments 30,000
divide by: LT 3
Annual rent expense 10,000
The first six months are rent-free

2. Give the journal entries of the lessee from 2019-2021.

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Under the recognition exemption, Entity A does not recognize a right-of-use asset and a
corresponding lease liability but instead recognizes the lease payments as expense on a straight line
basis.

December 31, 2019 Rent expense 10,000

Cash 4,000
Rent payable (squeeze) 6,000

December 31, 2020 Rent expense 10,000

Rent payable (squeeze) 2,000
Cash 12,000

December 31, 2021 Rent expense 10,000

Rent payable (squeeze) 4,000
Cash 14,000

 Operating Lease-Lessor
To understand operating lease and finance lease on the part of the lessor

IFRS16, par. 61, provides that a lessor shall classify leases as either an operating lease or a finance
lease.

Operating lease-does not transfer substantially all the risks and rewards incidental to ownership.

Finance lease-transfers substantially all the risks and rewards.

When is a lease classified as finance lease?

Any of the ffg. situations would normally lead to a lease being classified as a finance lease:
(Determinative in nature)
a. Transfers ownership
b. The lessee has an option to purchase the asset at a price sufficiently lower than the FV at the
date of option becomes exercisable
c. The lease term is for the major part of the economic life of the underlying asset.(75%, USA
GAAP=Lease term/Useful life)
d. PV of the lease payments amounts to substantially all of the FV of the asset at the inception
date (90%, USA GAAP)

Other Criteria could also lead to being classified as Finance Lease.(Suggestive in nature)
a. The underlying asset is specialized in nature that the only lessee can use it
b. If the lessee will cancel the lease, the lessor’s losses associated with the cancellation are
borne by the lessee
c. Gains or losses from the fluctuation in the FV of the residual accrue to the lessee
d. The lessee has the ability to continue the lease for a secondary period at a rent substantially
lower than the market rent.

Land and Building Lease as one or basket price, use relative fair value to allocate the lease payments
between the land and building elements.

Operating lease-Lessor
Rental income- periodic rental received by the lessor
The underlying asset remains as an asset of the lessor.
The lessor shall bear all the executory costs but may pass on to the lessee (taxes, insurance,
maintenance cost) except for the depreciation.

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Initial direct cost-shall be added to the CA of the underlying asset and recognize as an expense over
the lease term.
Security deposit-refundable upon the lease expiration shall be accounted as liability by the lessor.
Lease bonus received by the lessor is recognized as unearned rent income to be amortized over the
lease term.

Illustration:
On January 1, 2019, Study Company purchased a machinery for P3,000,000 cash for the purpose of
leasing it. The machine is expected to have a 10-year useful life and no residual value.
Machinery 3,000,000
Cash 3,000,000

On April 1, 2019 the machine was leased to another entity at a monthly rental of P50,000 payable
beginning of every month.
Cash (50,000 x 9) 450,000
Rent Income 450,000

On April1, 2019, received a security deposit of P600,000.

Cash 600,000
Liability for rent deposit 600,000

On January 1, 2019, received a lease bonus of P120,000.

Cash 120,000
Unearned rent income 120,000

On April1, 2019, paid initial direct cost of P300,000.

Deferred initial direct cost 300,000
Cash 300,000

Paid repair and maintenance of P20,000

Repair and maintenance 20,000
Cash 20,000

Lease bonus amortization over 3 years

Unearned rent income 30,000
Rent income (40,000 x 9/12) 30,000

Record the depreciation

Depreciation 300,000
Accumulated depreciation 300,000

Amortization of initial direct cost over the lease term

Amortization of IDC 75,000
Deferred IDC (300,000/3 yrs x 9/12) 75,000

Unequal rental payments

-Use the straight line basis on the recognition of income.
-the total cash payments for the lease term shall be amortized uniformly on the SL basis as rent
income over the lease term.

Illustration: JHS Company lease office space to another entity for a three-year period beginning
January 1, 2019.
Rent for the first year is P1,000,000 and next two years, P1,250,000.
As an inducement to enter the lease, JHS granted six months of the lease rent-free

2019 (1,000,000 x 6/12) 500,000

2020 1,250,000

13 | P a g e
2021 1,250,000
Total rental 3,000,000
Average rental (3M/3 years) 1,000,000

2019
Cash 500,000
Rent receivable 500,000
Rent income 1,000,000

2020
Cash 1,250,000
Rent income 1,000,000
Rent receivable 250,000

2021
Cash 1,250,000
Rent income 1,000,000
Rent receivable 250,000

Additional Illustrations:
A-Nes Company leased a new machine to Bes Company on January 1, 2019. The lease expires on
January 1, 2024. The annual rental is P900,000. Additionally, on January 1, 2019, Bes paid P500,000
to Nes as a lease bonus and P250,000 as a security deposit to be refunded upon expiration of the
lease.

What amount of rental revenue should be reported for 2019? 1,000,000

Annual rental 900,000
Amortization of lease bonus (500,000/5) 100,000
Total rental revenue 1,000,000

B-Marian Company purchased tractor on January 1, 2019 at a cost of P1,600,000 for the purpose of
leasing it. The tractor is estimated to have a useful life of 5 years with residual value of P100,000.
Depreciation is on a straight line basis. On April 1, 2019, Marian entered into a lease contract for the
lease of the tractor for a term of two years up to March 31, 2021. The lease fee is P50,000 monthly
and the lessee paid P600,000, the lease for one year. Marian paid P120,000 commission associated
with negotiating the lease, P15,000 minor repairs and P10,000 transportation of the tractor to the
lessee during the current year.

What amount of net rent revenue should be reported for the current year? 80,000

Rental from April 1 to December 31, 2019

(50,000 x 9) 450,000
Less: Depreciation (1,600,000-100,000/5) 300,000
Commission (120,000/2 x 9/12) 45,000
Repairs 15,000
Transportation 10,000 370,000
Net Rent revenue 80,000

 Direct Financing Lease- Lessor

To under the direct financing lease under the finance lease
To understand the investment and interest income using the effective interest method

Two types of finance lease on the part of the lessor

1. Direct financing lease-recognize only interest income

14 | P a g e
 2. Sales type lease-recognized interest income and gross profit

The lessor in a direct financing lease is actually engaged in the financing business. Thus, a direct
financing lease is an arrangement between a financing entity and a lessee.

Accounting considerations
a. Gross investment or Lease receivable=(Gross rentals over the lease term+ RV, whether
guaranteed or unguaranteed)
b. Net investment in the lease =(Cost of the asset or PV of gross rentals + any IDC paid by the
lessor)
c. Unearned interest income= (Gross investment-Net investment)
d. Initial Direct Cost= added to the net investment.

Note: IDC would reduce the amount of interest income over the lease term
If there is IDC, there is a need to compute the new implicit interest rate (most likely lower interest
rate than the original interest rate). The process is called “interpolation process or trial and error
approach.”

Journal Entries
To record the lease at the commencement date
Lease receivable (Gross investment) XX
Asset (NI) XX
Unearned interest Income XX

To record the annual collection of the rental

Cash XX
Lease receivable XX

Amortization table (DPIPPV)

Date Payment Interest Principal Present value

To record the amortization of the unearned interest income

Unearned interest income XX
Interest income XX

Note: If the annual rental is not given, use this formula:

“the procedure is to divide the net investment in the lease to be recovered from rental by present
value factor of an annuity of 1 for a number of periods using a desired rate of return to get the
annual rental.”

Annual Rental =NI/PV of OA (if there is no involved residual value or when the underlying asset will
be transferred to the lessee at the end of the lease term or the lease provides for a transfer of
ownership to the lessee at the end of the lease term)

Annual Rental =-NI-PV of Residual value/PV of OA (if the underlying asset will revert to the lessor)

*where, PV-present value

Illustration:
Direct financing lease-with initial direct cost
On January 1, 2019, Sipag Company leased a machinery to another entity with the following details:
Cost of machinery 1,518,650
Annual rental payable at the end of each year 500,000
Lease term 4 years
Useful life of machinery 4 years
Implicit interest rate before initial direct cost 12%

15 | P a g e
 Present value of annuity of 1 for 4 years at 12% 3.0373

On January 1, 2019, Sipag Company paid IDC of P66,300.

Solution:

Note: Always check the determinants (determinative or suggestive in nature) on the part of the
lessor if the lease is qualified as Finance Lease.
Lease term/useful life=major part (100%), therefore the problem is qualified as a Finance Lease.

Gross Rentals 2,000,000

Net investment 1,584,950
Unearned interest income 415,050

Machinery (IDC) 66,300

Cash 66,300

Lease receivable 2,000,000

Machinery 1,584,950
Unearned interest income 415,050

To record the annual collection:

Cash 500,000
Lease receivable 500,000

Note: because there is IDC, we must compute new interest rate.

Let’s check the computation of the annual rental. In the given problem, the annual rental is
P500,000.

Annual rental=1,584,950/3.0373=521,829.
If you have noticed, the given annual rental of P500,000 is not matched to what we have computed.
The reason behind this is the inclusion of the IDC in the problem. Meaning to say, the lessor is willing
to accept lower rate than the original interest rate.

How would you compute the new implicit interest rate?

Use the trial and error approach.
Let’s use the 10% rate with a period of 4 years, the equivalent PVOA of this is 3.1699

3.1699 x annual rental of P500,000= 1,584,950.

You will know that your interest rate is correct if the newly rate applied will arrive with the same
amount of Net investment of 1,584,950.

Amortization Table
Date Payment Interest(10%) Principal Present value
1/1/2019 1,584,950
12/31/2019 500,000 158,495 341,505 1,243,445
12/31/2020 500,000 124,344 375,656 867,789
12/31/2021 500,000 86,779 413,221 454,568
12/31/2022 500,000 45,432 454,568  -

To record the recognition of interest income

2019
Dec 31 Unearned interest income 158,495
Interest income 158,495

2020

16 | P a g e
Dec 31 Unearned interest income 124,344
Interest income 124,344

Statement of Financial Position presentation

Current portion
Lease receivable 500,000
Unearned interest income (124,344)
Carrying amount 375,656

Noncurrent portion
Lease receivable 1,000,000
Unearned interest income (132,211)
Carrying amount 867,789

Note: Again, if there is no IDC involved in the problem, you follow only the formulas of GI, NI and
Unearned Interest Income. And simply prepare the amortizable table by using the given implicit
interest rate.

Additional Illustrations:
A-Kobid Company is in the business of leasing new sophisticated equipment. As lessor, the entity
expects a 12% return. At the end of the lease term, the equipment will revert to Kobid Company. On
January 1, 2020 an equipment is leased to another entity under a direct financing lease.

Cost of equipment to Kobid 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 1/1/2020

1. What is the gross investment in the lease? 8,076,000

Gross rentals (959,500 x 8) 7,676,000
Residual value 400,000
Gross investment 8,076,000

2. What is the unearned interest income (total financial revenue) on January 1, 2020?
2,576,000

Gross investment 8,076,000

Net investment-equal to the cost of equipment (5,500,000)
Unearned interest income 2,576,000

3. What is the interest income for 2020? 544,860

PV of rentals 5,500,000
1st payment on January 1, 2020 (959,500)
Lease receivable-January 1, 2020 4,540,500

Interest income for 2020 (4,540,500 x 12%) 544,860

B-Lyro Company entered into a finance lease on January 1, 2019. A third party guaranteed the
residual value of the asset under the lease estimated to be P1,200,000 on January 1, 2024, the end
of the lease term.Annual lease payments are P1,000,000 due each December 31 beginning
December 31, 2019. The last payment is due December 31, 2023.The remaining useful life of the
asset was six years at the commencement of the lease. Both the lessor and 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%

17 | P a g e
for 5 periods is 3.79.

1. What is the net lease receivable of the lessor at the commencement of the lease? 4,534,000
PV of rentals (1,000,000 x 3.79) 3,790,000
PV of residual value guarantee (1,200,000 x .62) 744,000
Net lease receivable or net investment 4,534,000

2. What is the gross investment in the lease? 6,200,000

Gross rentals (1,000,000 x 5) 5,000,000

Guaranteed residual value 1,200,000
Gross investment 6,200,000

3. What is the total unearned interest income? 1,666,000

Gross investment 6,200,000
Net investment (4,534,000)
Unearned interest income 1,666,000

4. What is the interest income for 2019? 453,400

Interest income for 2019 (10% x 4,534,000) 453,400

 Sales Type Lease- Lessor

To under the sales type lease under the finance lease
To understand the investment, gross profit and interest income using the effective interest method

The lessor in a sales type lease is actually a manufacturer or dealer that uses the lease as a means of
facilitating the sale of product. It involves the recognition of a manufacturer or dealer profit on the
transfer of the asset to the lessee in addition to the recognition of interest income.

Accounting considerations
Gross investment/Lease Receivable= (Gross rentals over the lease term + purchase option or
residual value, whether guaranteed or unguaranteed)
Net investment in the lease/Sales= (PV of the gross rentals + PV of Purchase option or PV of the
residual value, whether guaranteed or unguaranteed)
Unearned interest income= (Gross investment- net investment)
Sales-=Net investment in the lease or FV of the asset, whichever is lower
Cost of goods sold= (Sales-cost of goods sold)
*Initial direct cost is expensed immediately in a sales type lease as component of cost of goods sold

Journal Entries:
To record the sale:
Lease receivable XX
Sales XX
Unearned interest income XX

To record the cost of goods sold:

Cost of goods sold XX
Inventory XX

To record the collection of the annual rental:

Cash XX
Lease receivable XX

To record the interest income:

Unearned interest income XX

18 | P a g e
 Interest income XX

Illustration:
Manuel Company is a dealer in machinery. On January 1, 2019, a machinery is leased to another
entity with the following provisions:
Annual rental payable at the end of each year 800,000
Lease term 5 years
Useful life of machinery 5 years
Cost of machinery 2,000,000
Estimated residual value 200,000
Initial direct cost paid by the lessor 100,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.7908
PV of 1 for 5 periods at 10% 0.6209

At the end of the lease term on December 31, 2023, the machinery will revert to Manuel Company.
The perpetual inventory system is used.

Solution:
Note: Again, since you are the lessor, check the problem if qualifies as FL. If qualified as FL, identify it
either as Direct Financing Lease (DFL) or Sales Type Lease (STL).

Whether the residual value is guaranteed or unguaranteed, the lease receivable (LR), unearned
interest income (UII) and gross income are the same.

19 | P a g e
Amortization Table
Date Payment Interest Principal Present value
1/1/2019 3,156,820
12/31/2019 800,000 315,682 484,318 2,672,502
12/31/2020 800,000 267,250 532,750 2,139,752
12/31/2021 800,000 213,975 586,025 1,553,727
12/31/2022 800,000 155,373 644,627 909,100

20 | P a g e
 12/31/2023 800,000 90,900 709,100 200,000

Journal Entries-December 31, 2019

Cash 800,000
Lease receivable 800,000

Unearned interest income 315,682

Interest income 315,682

Return of asset to lessor on December 31, 2023 (whether guaranteed or unguaranteed) P200,000
Inventory (Machinery) 200,000
Lease receivable 200,000

When the FV guaranteed RV is only P150,000

Cash 50,000
Inventory 150,000
Lease Receivable 200,000

Unguaranteed RV, when the RV is only P150,000

Loss on finance lease 50,000
Inventory 150,000
Lease Receivable 200,000

Note: if the underlying asset will not revert back to the lessor, the RV is completely ignored by the
lessor in computing the UII and gross profit.

Actual sale of underlying asset

Carrying amount of the lease receivable=balance of Lease Receivable-Unearned Interest Income

Gain/loss on sale (recognized in profit or loss or income statement=Sales Price-CA of the LR

Illustration:
An entity actually sold an equipment that it had been leasing under a sales type lease (STL) for
P3,500,000. The following balances are associated with the finance lease on the books of the lessor
on the date of sale:

Lease receivable (LR) 5,000,000

Unearned Interest Income (UII) 1,200,000

Solution:
Sales price 3,500,000
CA of LR:
LR 5,000,000
UII (1,200,000) 3,800,000
Loss on sale of leased equipment (300,000)

Journal Entry to record the actual sale

Cash 3,500,000
UII 1,200,000
Loss on sale of leased equipment 300,000
LR 5,000,000

Additional Illustration:
A-Kyle Company used leases as a method of selling products. In 2020, the entity completed
construction of a passenger ferry. On January 1, 2020, the ferry was leased to the Super Ferry Line
on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease
period.Annual lease payments do not include executory costs.

21 | P a g e
 Original cost of the ferry 8,000,000
Fair value of ferry at lease date 13,000,000
Lease payments payable in advance 1,500,000
Estimated residual value 2,000,000
Implicit interest rate 12%
Date of first lease payment 1/1/2020
Lease term 20 years
PV of an annuity in advance due of 1 at 10% for 20 periods 8.37
PV of 1 at 12% for 20 periods 0.10

1. What is the unearned interest income on January 1, 2020? 17,445,000

Gross rentals (1,500,000 x 20) 30,000,000
PV of rentals (1,500,000 x 8.37) 12,555,000
Unearned interest income-Jan 1, 2020 17,445,000

*PV of rental is lower than the FV of the asset

*residual value is ignored because the ownership will transfer to the lessee

2. What is the gross profit on sale for 2020? 4,555,000

PV of rentals-sales revenue 12,555,000
Cost of goods sold 8,000,000
Gross profit on sale 4,555,000

3. What is the interest income for 2020? 1,326,600

PV of rentals 12,555,000
Payment on January 1, 2020-all applicable to principal (1,500,000)
Lease receivable-January 1, 2020 11,055,000

Interest income for 2020 (11,055,000 x 12%) 1,326,600

B-An entity is a dealer in equipment. At the beginning of current year, an equipment was leased to
another entity with the following provisions:

Annual rental payable at the end of each year 1,500,000

Lease term and useful life of machinery 5 years
Cost of equipment 4,000,000
Fair value of equipment on date of lease 6,000,000
Guaranteed residual value 500,000
Implicit interest rate 12%
PV of an ordinary annuity of 1 for 5 periods at 12% 3.60
PV of 1 for 5 periods at 12% 0.57

The equipment will revert to the lessor at the end of the lease term. The fair value of the asset is
P350,000 at the end of the lease term. The perpetual inventory system is used. The lessor incurred
initial direct cost of P200,000 in finalizing the lease agreement.
1. What is the gross investment in the lease? 8,000,000
Gross rentals (1,500,000 x 5) 7,500,000
Guaranteed RV 500,000
8,000,000

2. What is the net investment in the lease? 5,685,000

PV of rentals (1,500,000 x 3.60) 5,400,000
PV of Guaranteed RV (500k x 0.57) 285,000

22 | P a g e
 5,685,000

3. What is the total financial revenue? 2,315,000

Gross Investment 8,000,000
Net investment 5,685,000
2,315,000

4. What amount of interest income should be recognized for the current year? 682,200
5,685,000 x 12% 682,200

5. What amount should be reported as profit on sale for the current year? 1,485,000
Sales (lower,PV or FV) 5,685,000
COS (4m + 200k) 4,200,000
1,485,000

 Sale and Leaseback

To understand the sale and leaseback
To know the recognition of a transfer of asset that is not a sale

Sale and leaseback (Operating or Finance Lease) is an arrangement whereby one party sells an asset
to another party and then immediately leases the asset back from the new owner.
Seller becomes a seller-lessee Buyer becomes a buyer-lessor

This transaction occurs during the seller-lessee is experiencing financing problem or the seller-lessee
would like to avoid the burden of paying executory costs (repairs, insurance and taxes).

There is no physical transfer of asset.

Two (2) transactions that is recognized separately

1. Sale 2. Lease Agreement

Note: on the part of the lessor, check if the transaction qualifies for Operating lease or Finance
Lease.

Measurement of ROU under sale and leaseback

ROU=PV of LL/SP or FV x CA of the asset

Sales price >FV= Additional financing

Sales price <FV= Prepayment of lease payment
Sales Price = FV =no prepayment or additional financing

If the lease resulted as Operating Lease:

On the part of the lessor, refer to the discussion on Operating Lease-Lessor
On the part of the lessee, either account it as short-term value or low value with the recognition of
rent expense.

Gain or loss on the sale should be allocated as

1. Gain or loss to be recognized by the seller
2. Gain or loss not to be recognized by the seller

Rights on the sale should be allocated as

1. Right retained by seller-lessee
2. Right transferred to buyer-lessor

Annual Rental on the sale should be allocated as

23 | P a g e
 1. Annual rental income
2. Rent related to financing

Illustration I:
On January 1, 2020, David Company sold a building and immediately leased it back. The following
data pertain to the sale and leaseback transaction:
Sale price 9,000,000
FV of building 8,000,000
CA of building 7,200,000
Annual rental payable at the end of each year 600,000
Remaining life of building 20 years
Lease term 4 years
Implicit interest rate 12%
PV of an OA of 1 at 12% for four periods 3.037

1. What is the initial lease liability? 1,822,200

Initial LL (600,000 x 3.037) 1,822,200

2. What is the cost of ROU? 739,980

Sale Price (SP) 9,000,000
FV 8,000,000
Excess SP-additional financing 1,000,000
PV of rentals 1,822,200
PV related to financing (1,000,000)
PV related to lease 822,200

Cost of ROU (822,200/8,000,000 x 7,200,000) 739,980

3. What is the gain on right transferred to buyer-lessor? 717,780

FV of building 8,000,000
CA 7,200,000
Total gain on sale 800,000
FV of building 8,000,000
Right retained by seller-lessee (822,200)
Right transferred to buyer-lessor 7,177,800
Gain to recognized (7,177,800/8,000,000 x 800,000) 717,780
Gain not to be recognized (822,200/8,000,000 x 800,000) 82,2220

4. What is the annual rental income of the buyer-lessor? 270,728

PV related to rental income 822,000

PV related to financing 1,000,000
Total PV of rentals 1,822,200

Annual rental income (822,200/1,822,200 x 600,000) 270,728

Rent related to financing (1,000,000/1,822,200 x 600,000) 329,272
Total 600,000
Books of Seller-Lessee:
Cash 9,000,000
ROU 739,980
Bldg 7,200,000

24 | P a g e
 LL 1,822,200
Gain on right transferred 717,780

Interest Expense (12% X 1,822,200) 218,664

LL 381,336
Cash 600,000

Depreciation (739,980/4 years) 184,995

Accu. Depreciation 184,995

Books of Buyer-Lessor
Bldg 8,000,000
Financial asset 1,000,000
Cash 9,000,000

Cash 270,728
Rent Income 270,728

Cash 329,272
Financial Asset 209,272
Interest Income 120,000

Depreciation (8,000,000/20 years) 400,000

Accu. Depreciation 400,000

PV Fraction Allocation
Rental Income 822,200 822,200/1,822,200 270,728
Financial Asset 1,000,000 1,000,000/1,822,200 329,272
Total PV 1,822,200 600,000

Date Payment 12% Principal Allocation

1/1/2020 1,000,000
12/31/2020 329,272 120,000 209,272 790,728
12/31/2021 329,272 94,887 234,385 556,343
12/31/2022 329,272 66,761 262,511 293,833
12/31/2023 329,272 35,439 293,833

Illustration II:
On January 1, 2020, Hazel Company sold a machine and immediately lease it back. The following
data pertain to the sale and leaseback transaction:

Sale price 4,000,000

FV of machine 4,500,000
CA 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%
2.67
PV of an OA of 1 at 6% fpr 3 periods

25 | P a g e
1. What is the lease liability? 1,335,000
Initial lease liability (500,000 x 2.67) 1,335,000

2. What is the cost of ROU? 1,468,000

FV 4,500,000
SP 4,000,000
Excess FV-prepayment of rental 500,000

Initial lease liability 1,335,000

Excess FV-prepayment of rental 500,000
Total lease liability 1,835,000

Cost of ROU (1,835,000/4,500,000 x 3,600,000) 1,468,000

3. What is the gain on right transferred to the buyer-lessor? 533,000

FV 4,500,000
CA 3,600,000
Total gain on sale 900,000

FV 4,500,000
Right retained by seller-lessee equal to lease liability 1,835,000
Right transferred to buyer-lessor 2,665,000

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

4. What is the net annual rent income of the buyer-lessor? 100,000

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

Illustration III
On January 1, 2019, Lee Company sold equipment to an unaffiliated entity at the fair value of
P5,000,000. The equipment had a carrying amount of P4,500,000 and a remaining life of 10 years.
That same day, Lee Company leased back the equipment at P15,000 per month for 2 years with no
option to renew the lease or repurchase the equipment. The present value of the lease payments
using the appropriate interest rate was P318,650 on January 1, 2019.
1. What is the initial lease liability? 318,650
2. What is the cost of right of use asset?
318,650/5,000,000 x 4,500,000=286,785
3. What is the annual depreciation of the right of use asset? 143,392
4. What is the gain on right transferred to the buyer-lessor? 468,135
Fair value 5,000,000
CA 4,500,000
Total gain on sale 500,000
Fair value 5,000,000
Right retained by seller-lessee (318,650)
Right transferred to buyer-lessor 4,681,350
Gain to be recognized (4,681,350/5,000,000 x 500,000) 468,135

Illustration IV
At the beginning of the current year, an entity sold a machinery with a remaining life of 10 years for
P2,000,000 which is equal to the fair value of the machinery. The entity immediately leased the
machinery back for 1 year at the prevailing annual rental of P300,000. The machinery has a carrying

26 | P a g e
amount of P1,800,000, net of accumulated depreciation of P1,200,000.

Book of seller-lessee
1. To record the sale:
Cash 2,000,000
Accumulated depreciation 1,200,000
Machinery 3,000,000
Gain on right transferred 200,000

2. To record annual rental:

Rent Expense 300,000
Cash 300,000
The seller-lessee used the operating lease model because the lease is short-term or one year.

Book of buyer-lessor
1. To record the purchase:
Machinery 2,000,000
Cash 2,000,000

2. To record the annual rental:

Cash 100,000
Rent income 100,000

3. To record depreciation of the machinery:

Depreciation 200,000
Accumulated depreciation 200,000
(2M/10)

CLOSURE ACTIVITIES
Activity#1- Midterm
Leases

The following work exercises intend to evaluate what the learners have learned in this topic. Write
your answers in your portfolio journal. Show your solutions in good form.

Lessee Accounting

Problem A
On January 1, 2019, Kayako Company leased a building from a lessor with the following pertinent
information:

1,000,00
Annual rental payable at the end of each year
0
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
5
Lease term
years
8
Useful life of building
years
Implicit interest rate 10%

27 | P a g e
 PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
PV of 1 for 5 periods at 10% 0.62

1. What is the carrying amount of the right of use asset on December 2021?
2. What is the total depreciation for 2019?
3. What is the total interest expense to be recognized over the lease?
4. What is the lease liability on December 31, 2023?

Problem B
Nag-aral Company entered into a lease of building on January 1, 2019 with the following
information:

Annual rental payable at the end of each year 500,000

Lease term 5 years
Useful life of building 20 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 5 periods 3.79

The lease contained an option for the lessee to extend for a further 5 years.
At the commencement date, the exercise of the extension option is not reasonably certain.
After 3 years on January 1, 2022, the lessee decided to extend the lease for a further 5 years.

New annual rental payable at the end of each year 600,000

New implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for 5 periods 3.99
PV of 1 at 8% for 2 periods 0.86
PV of an ordinary annuity of 1 at 8% for 2 periods 1.78

5. What is the lease liability on December 31, 2021?

6. What is the accumulated depreciation for 2021?
7. What is the adjustment of the carrying amount of the right of use asset due to the
remeasurement of the lease liability?
8. What is the carrying amount of right of use asset on January 1, 2022?
9. What is the depreciation for 2022?

Problem C
On January 1, 2019, Nochiting Company entered into a ten-year noncancelable lease requiring year-
end payments of P1,000,000.
Nochiting’s incremental borrowing rate is 12%, while the lessor’s implicit interest rate, known to
Nochiting, is 10%.
Present value factors for an ordinary annuity for ten periods are 6.145 at 10%, and 5.650 at 12%.
On same date, Nochiting Company paid initial direct cost of P200,000 in negotiating and securing the
leasing arrangement.
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.

10. What amount should be capitalized initially as cost of the right of use asset?
11. What amount should be recognized initially as lease liability?
12. What is the annual depreciation of the right of use asset?

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Problem D
On January 1, 2019, Papasa Company leased a building from Babagsak with the following pertinent
information:

Lease term 5 years

Annual rental payable at beginning of each year 500,000
Useful life of building 8 years
Implicit interest rate in lease 12%
PV of an annuity of 1 in advance for 5 periods at 12% 4.04
PV of an ordinary annuity of 1 for 5 periods at 12% 3.60
Restoration cost that will shoulder by the lessor as per contract 100,000
Executory cost 28,000
Installation of new walls and office 50,000

The lease is not renewable and the building reverts to Babagsak at the termination of the lease. The
cost of the building on Babagsak’s accounting records is P3,755,000.

13. At the beginning of the lease term, what amount should be recorded as cost of right of use
asset?
14. What is the depreciation of the right of use asset for the current year?

Problem E
On July 1, 2019, Matalinaw Company leased office space for 1 year at P150,000 a month. On that
date, Matalinaw paid the lessor the following amounts:

Rent security deposit 350,000

First month’s rent 150,000
Last month’s rent 150,000
Nonrefundable reimbursement to lessor
for modifications to the leased premises 900,000
1,550,000
Matalinaw made timely rental payments from August 1 through December 1, 2019.

15. What total amount related to lease should Matalinaw be deferred or recognized beyond 2019?

Problem F
Kota Company leases and operates a retail store for 1 year. The following information relates to the
lease for the year ended December 31, 2019.

o The store lease, an operating lease, calls for a base monthly rent of P15,000 on the first day
of each month.
o Additional rent is computed at 6% of net sales over P3,000,000 up to P6,000,000 and 5% of
net sales over P6,000,000 at the end of the year.
o Net sales for 2019 amounted to P9,000,000.
o Kota paid executory costs to the lessor for property taxes of P120,000 and insurance of
P50,000.
16. What total amount of the expenses relating to the store lease should be reported for 2019?

Lessor Accounting

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Problem G
Ginalingan Company purchased a machine on January 1, 2019 for P5,000,000 for the express
purpose of leasing it.

The machine was expected to have a 10-year life with no residual value and the straight line method
of depreciation is used.

On March 1, 2019, Ginalingan Company leased the machine to Bessy Company for P1,200,000 a year
for a 4-year period ending February 28, 2023.

Ginalingan Company paid a total of P60,000 for maintenance and received P1,200,000 from Bessy
Company on March 1, 2019.

Ginalingan Company retains title to the property and plans to lease it to someone else after the 4-
year lease period.

17. Determine the net rent income of Ginalingan Company for 2019?

Problem H
On January 1, 2019, Sinog Company leased a building to Kilay Company under a four-year lease term.
The building has an estimated useful life of six years with a fair value amount of P10,000,000.The
monthly rental for 2019, 2020, 2021 and 2022 is P100,000, P150,000, P200,000 and P250,000,
respectively. Rentals are payable at the end of each month. All rental payments within the year were
made when due.

18. What rent income should be recognized for the year ended December 31, 2019?
19. In Sinog’s December 31, 2020 statement of financial position, what rent receivable should be
reported?

Problem I
Nanalo Company is in the business of leasing new sophisticated equipment.

Such an equipment was delivered to a lessee on January 1, 2019 under a direct financing lease with
the following provisions:

Cost of equipment 3,390,000

Annual rental payable at the end of year 600,000
Useful life and lease term 10 years
Implicit interest rate 12%
PV of an ordinary annuity of 1 at 12% for 10 years 5.650

The entity incurred and paid initial direct costs of P143,400 in negotiating and arranging the lease.

The equipment will revert to Nanalo Company at the end of the lease.

20. Compute the total financial revenue to be recognized over the lease term.
21. Determine the new implicit rate that will be used in computing interest income. (use 3 decimal
places for PVOA factors)

Problem J

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Aralmuna Company buys equipment for leasing to various manufacturing entities.

On January 1, 2019, Aralmuna Company leased an equipment to another entity.

The cost of the equipment to Aralmuna Company was P1,377,480 which approximates the fair value
on the lease date. The expected economic life of the equipment is also 4 years.

The lease payments stipulated in the lease are P440,000 per year in advance for a 4-year period of
the lease. The payments include P40,000 executory costs per year.

The title to the equipment remains in the hands of Aralmuna Company at the end of the lease term,
although only nominal residual value is expected at that time.

The implicit interest rate in the lease is 11%. The fiscal year of Aralmuna Company ends December
31.

22. Compute the total financial revenue.

23. What is the interest income for the year 2021?

Problem K
Andali Company used leases as the primary method of selling products. The entity’s main product is
a small helicopter that is very popular among government officials and corporate executives.

Andali Company constructed such a helicopter for a Cabinet Secretary at a cost of P8,000,000.

The terms of the lease provided for annual rental of P3,328,710 to be paid over 5 years every
December 31 of each year with the ownership of the helicopter transferring to the lessee at the end
of the lease term.

It is estimated that the helicopter will have a residual value of P500,000 after 5 years.

Andali Company incurred initial direct costs of P200,000 in finalizing the lease with the lessee.

Financing the construction was at a 12% rate. The present value of an ordinary annuity of 1 for 5
periods at 12% is 3.605.

24. Compute the total unearned financial revenue.

25. Compute the manufacturer profit to be recognized immediately.
26. Compute the interest income for the first year.

Problem L
Tres Company is a dealer in equipment. On January 1, 2019, the entity leased equipment to another
entity. The lease is appropriately recorded as a sales type lease.

Annual rental payable at the beginning of each year 875,000

Lease term 8 years
Useful life of equipment 10 years
3,100,00
Cost of equipment
0
5,200,00
Fair value of equipment
0

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 Purchase option 300,000
Implicit interest rate 10%
PV of an annuity of 1 in advance at 10% for 8 periods 5.8684
PV of 1 at 10% for 8 periods 0.4665

It is reasonably certain that the lessee will exercise the purchase option on the expiration of lease on
December 31, 2026.

The perpetual inventory system is used by Tres Company.

27. Determine the unearned interest income on January 1, 2019.

28. Determine the gross profit on sale.

Sale & Leaseback

Problem M
On January 1, 2019, Kitakita Company sold an equipment with remaining life of 10 years and
immediately leased it back for 4 years at the prevailing market rental.

6,000,00
Sale price at fair value
0
4,500,00
Carrying amount of equipment
0
Annual rental payable at the end of each year 800,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for four periods 3.17

29. What is the initial lease liability?

30. What is the cost of right of use asset?
31. What is the gain on right transferred to the buyer-lessor?
32. What is the annual depreciation of the right of use asset?
33. What is the annual net rental income of the buyer-lessor?

Problem N
On January 1, 2019, Noriteyk 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 of 1 at 12% for five periods 3.60

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

35. What is the depreciation of the building of the buyer-lessor?
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Isaiah 43:1 But now, this is what the LORD says—he who created you, Jacob,he who formed you,
Israel: “Do not fear, for I have redeemed you;I have summoned you by name; you are mine.

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