Updates in PFRSs Topic 2

Illustration 1
On January 1, 20x1, A Co. leased equipment to X Inc. Information on the lease is shown below.

Cost of equipment P303,735

Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year 100,000
Interest rate implicit in the lease 12%

Solution: The lease is classified as finance lease.

 The lease term is 80% (4yrs. ÷ 5 yrs.) of the useful life of the leased asset.

Initial measurement:

Fixed lease payments 100,000

Multiply by: lease term 4
Gross investment in the lease 400,000

Fixed lease payments 100,000

x PV of ordinary annuity, 12%, n=4 3.03735
Net investment in the lease 303,735

Gross investment 400,000

Net investment 303,735
Unearned interest income 96,265

Jan. 1, 20x1 Finance lease receivable 400,000

Equipment 303,735
Unearned interest income 96,265

Subsequent measurement:
Date Collections Interest Amortization Present value
1/1/x1 303,735
12/31/x1 100,000 36,448 63,552 240,183
12/31/x2 100,000 28,822 71,178 169,005
12/31/x3 100,000 20,281 79,719 89,286
12/31/x4 100,000 10,714 89,286 0

Dec. 31, 20x1 Cash 100,000

Unearned interest income 35,448
Finance lease receivable 100,000
Interest income 35,448

Illustration 2
On January 1, 20x1, A Co. leased equipment to X Inc. under a finance lease. Information on the lease follows:
Cost of equipment P320,183
Useful life of equipment 5 years
Lease term 4 years
Updates in PFRSs Topic 2

Annual rent payable at the beginning of each year P100,000

A incurred initial direct costs of P20,000 in negotiating the lease. The implicit interest rate is 12%.

Compute for the following:

a. Gross investment in the lease on January 1, 20x1
b. Net investment in the lease January 1, 20x1
c. Unearned interest income on January 1, 20x1

Solution:

Initial measurement:
Fixed lease payments 100,000
Multiply by: lease term 4
Total 400000
Less: Lease payment received 100,000
Gross investment in the lease 300,000

Fixed lease payments 100,000

x PV of annuity due, 12%, n=4 3.40183
Total 340,183
Less: Lease oayment received 100,000
Net invesment in the lease 240,183

Gross investment 300,000

Net investment 240,183
Unearned interest income 59,817

The initial direct costs are automatically included in the net investment in the lease. This is because the
implicit interest rate is computed as the rate that would equate the following:
PV of lease PV of unguaranteed Fair value of asset Initial direct
+ = +
payments residual value (equal to cost) cost
340,183 + 0 = 320,183 + 20,000

Dec. 31, 20x1 Cash 100,000

Finance lease receivable 300,000
Unearned interest income 59,817
Equipment 320,183
Cash 20,000

Subsequent measurement:
Date Collections Interest Amortization Present value
1/1/x1 340,183
12/31/x1 100,000 100,000 240,183
12/31/x2 100,000 28,822 71,178 169,005
12/31/x3 100,000 20,281 79,719 89,286
12/31/x4 100,000 10,714 89,286 - 0

Illustration 3
On January 1, 20x1, A Co. leased equipment to X, Inc. Information on the lease is shown below:
Cost of equipment P303,735
Updates in PFRSs Topic 2

Useful life of equipment 5 years

Lease term 4 years
Annual rent payable at the beginning of each year P100,000

Compute for the following:

a. Net investment
b. Interest rate implicit in the lease that would give A a fair rate of return on its net investment.

Solution:
(a) Net investment
PV of lease PV of unguaranteed Fair value of asset Initial direct
+ = +
payments residual value (equal to cost) cost
? + 0 = 303,735 + 0

Net investment = 303,735

(b) Implicit interest rate

Trial and error process: Assume any interest rate. Compute the present value of P100,000 lease
payment. The present value should be equal to the net investment of P303,735.

Hint: Factor we are looking for is equal to 3.03735 (303,735 ÷ 100,000)

Factor
22% 3.042241 (a)
? 3.037350 (b)
24% 2.981303 (c )

If the factor do not fall on the exact interest rate,

interpolation method will be used.

Using the lower rate

i = 22% + {(24% - 22%) x [(a-b) ÷ (a-c)]}
= 22.16%

Using the higher rate

i = 24% - {(24% - 22%) x [(b-c) ÷ (a-c)]}
= 22.16%

Illustration 4
On January 1, 20x1, A Co. leased equipment to XYZ Inc. Information on the lease is shown below:
Cost of equipment P300,000
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the start of each year P100,000
Market rate of interest 10%
Updates in PFRSs Topic 2
A Co. incurred direct costs (broker’s commission) of P20,000 in negotiating the lease. The lease qualifies
as a sales type lease.

Required: Compute the following

a. Gross investment in the lease on January 1, 20x1.
b. Net investment in the lease on January 1, 20x1.
c. Total interest income to be recognized over the lease term.
d. Gross profit and net profit from the sale.

Solution:
Fixed lease payments 100,000
Multiply by: lease term 4
Total 400,000
Less: Lease payment received 100,000
(a) Gross investment in the lease 300,000

Fixed lease payments 100,000

x PV of annuity due, 10%, n=4 3
Total 348,685
Less: Lease oayment received 100,000
(b) Net invesment in the lease 248,685

Gross investment 300,000

Net investment 248,685
(c)Unearned interest income 51,315

Sales (net investment + first lease payment) 348,685

Less: Cost of sales (cost of equipment) 300,000
(d)Gross profit 48,685
Less: Direct costs (charged as commission expense) 20,000
Net profit from sale 28,685

Jan. 1, 20x1 Finance lease receivable 300,000

Cash 100,000
Sales 348,685
Unearned interest income 51,315

Jan. 1, 20x1 Cost of sales 300,000

Inventory 300,000

Jan. 1, 20x1 Commission expense 20,000

Cash 20,000

Amortization:
Date Collections Interest Amortization Present value
1/1/x1 348,685
1/1/x1 100,000 100,000 248,685
1/1/x2 100,000 24,869 75,132 173,554
1/1/x3 100,000 17,355 82,645 90,909
1/1/x4 100,000 9,091 90,909 - 0