NEW BRIGHTON SCHOOL OF THE PHILIPPINES, Inx`C.

Module No. 7
Subject: Intermediate Accounting 2 Date of Submission: ____________
Name of Student: __________________________________________________
Course and Year: __________________________________________________
Semester and School Year: __________________________________________

EXTENSION OPTION

An entity entered into a lease of building on January 1, 2020 with the following information:

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

Lease term 5 years
Useful life 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, 2023, 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

Table of amortization

Date Payment Interest Principal Present value

1/1/2020 1,895,500
12/31/2020 500,000 189,550 310,450 1,585,050
12/31/2021 500,000 158,505 341,495 1,243,555
12/31/2022 500,000 124,355 375,645 867,910

December 31, 2020

Payment on December 31, 2020 500,000

Interest expense for 2020 (1% x 1,895,500) (189,550)
Applicable to principal 310,450

Present value – January 1, 2020 (500,000 x 3.791) 1,895,500

Principal payment on December 31, 2020 (310,450)
Lease liability – December 31, 2020 1,585,050

Journal entries for 2020

Jan. 1 Right of use asset 1,895,500

Lease liability 1,895,500

Dec. 31 Interest expense 189,550

Lease liability 310,450
Cash 500,000

31 Depreciation (1,895,500 / 5 years) 379,100

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 Accumulated depreciation 379,100

Remeasurement of lease liability

On January 1, 2023, 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 ordinary annuity of 1 at 8% for 2 periods 1.783
Present value – January 1, 2023 891,500

Annual rental for 5 years starting January 1, 2025 600,000

Multiply by PV of an ordinary annuity of 1 at 8% for 5 periods 3.993
Present value – January 1, 2025 2,395,800
Multiply by PV of 1 at 8% for 2 periods 0.857
Present value – January 1, 2023 2,053,200

The present value of the new rentals on January 1, 2025 is rediscounted for 2 periods on the date of extension on
January 1, 2023.

Present value of remaining rentals of old lease term 891,500

Present value of rentals of extended lease term 2,053,200
Total present value – January 1, 2023 2,944,700
Present value – December 31, 2002 (867,910)
Increase in lease liability on January 1, 2023 2,076,790

Right of use asset – January 1,2020 1,895,500

Accumulated depreciation – December 31, 2020
(379,100 x 3 years) (1,137,300)
Carrying amount – December 31, 2022 758,200
Increase in liability on January 1, 2023 2,076,790
New carrying amount – January 1, 2023 2,834,990

IFRS 16, paragraph 39, provides that the measurement of the lease liability is an adjustment of carrying amount of the
right of use asset.

Table of amortization

(8%)
Date Payment Interest Principal Present value

1/1/2023 2,944,700
12/31/2023 6,000,000 235,576 264,424 2,680,276
12/31/2024 6,000,000 214,422 285,578 2,394,698
12/31/2025 6,000,000 191,576 408,424 1,986,274
12/31/2026 6,000,000 158,902 441,098 1,545,176
12/31/2027 6,000,000 123,614 476,386 1,068,790
12/31/2028 6,000,000 85,503 514,497 554,293
12/31/2029 6,000,000 45,707 55,293

8% x P554,293 equals P44,343

There is a different of P1,364 due to rounding of present value factor.

Journal entries for 2023

1. To remeasure the lease liability on January 1, 2023

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 Right of use asset 2,076,790
Lease liability 2,076,790

To increase in lease liability is an adjustment of the carrying amount of the right of use asset.

2. To record the annual rent on December 31, 2023

Interest expense 235,576

Lease liability 264,424
Cash 500,000

3. To record the annual depreciation based on the new carrying amount:

Depreciation 404,999
Accumulated depreciation 404,999

The total lease term is 10 years minus 3 years expired equals remaining term of 7 years.

VARIABLE PAYMENTS

On January 1, 2020, an entity entered into an 8 years lease of a floor of a building with the following terms:

Annual rental for the first three years payable at the end of each years 300.000
Annual rental for the next five years payable at the end of each years 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.

Computation
Annual rental for first three years 300,000
Multiply by PV of an ordinary annuity of 1 at 10% for three periods 2.487
Present value – January 1,2020 746,100
Annual rental for next five periods 400,000
Multiply by PV of an ordinary annuity of 1 at 10% for five years. 3.791
Present value – January 1. 2023 1,516,400
Multiply by PV of 1 at 10% for three years periods. 0.751
Present value – January 1, 2020 1,138,816

The present value of the annual rental for the next five years starting January 1, 2023 is rediscount for three periods at
the beginning of the lease on January 1,2020

Present value of annual rentals for three years 746,100

Present value of annual rentals for next five years 1.138,816
Lease liability- January 1, 2020 1,884,916

Table of amortization

(10%)
Date Payment Interest Principal Present
value
1/1/2020 1,884,916
12/31/2020 300,000 188,492 111,508 1,773,408
12/31/2021 300,000 177,341 122,659 1,650,749
12/31/2022 300,000 165,075 134,925 1,515,824
12/31/2023 400,000 151,582 2248,418 1,267,406
12/31/2024 400,000 126,741 273,259 994,147
12/31/2025 400,000 99,415 300,585 693,562

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12/31/2026 400,000 69,356 300,644 362,918
12/31/2027 400,000 37,082* 362,918 -

*10% x P362,918 equals P36,292.

There is a difference of P790 due to rounding of present value factor.

Journal entries for 2020

1. Right of use asset 1,884,916
Lease liability 1,884,916

2. Interest expense 188,492

Lease liability 111,508
Cash 300,000

3. Depreciation 235,615
Accumulated depreciation 235,615
(1,884,916 / 8 years)

The depreciation is based on the lease term of 8 years because there is neither a transfer of title nor purchase option.

Lease Modification

IFRS 16, paragraph 44, provides that the lessee shall account for the lease modification as a separate lease under the
following conditions:

a. The modification increases the scope of the lease by adding the right to use an additional underlying asset.

b. The rental for the lease modification increase by an amount commensurate with the increase in scope and
equivalent to the current market rental.

Illustration

On January 1, 2020, an entity entered into lease agreement with the following information:
Floor space 3,000 square meters
Annual rental payable at the end of each year 100,000
Implicit rate in the lease 10%
Lease term 8 years
Present value of an ordinary annuity of 1 at 10% for 8 periods 5.3349

On January 1, 2022, the entity and the lessor agreed to amend the original terms of the lease with the following
information:

Additional floor space 4,500 square meters

Increase in rental payable at the end of each year 200,000
Implicit rate in the lease 8%
Present value of an ordinary annuity of 1 at 8% for 6 periods 4.6229

The increase in the rental for additional 4,500 square meters is equivalent to the current market rent.

Journal entries for 2020

Present value of the lease payments – January 1, 2020

(100,000 x 5.3349) 533,490

Jan. 1 Right of use asset 533,490

Lease liability 533,490

Dec. 31 Interest expense 53,349

Lease liability 46,651
Cash 100,000

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 31 Depreciation 66,686
Accumulated depreciation 66,686

On January 1, 2022, the entity shall account for the modification as a separate lease.

The entity shall recognize the right of use asset and lease liability for the additional 4,500 square-meter lease space on
January 1, 2022.

No adjustment is made to the 3,000 square meter lease because of the modification.

Present value of the additional lease payment

on January 1, 2022 (200,000 x 4.6229) 924,580

Journal entries for 2022 – new separate lease

Jan. 1 Right of use asset 924,580

Lease liability 924,580

Dec. 31 Interest expense (924,580 x 8%) 73,966

Lease liability 126,034
Cash 200,000

31 Depreciation 154,097
Accumulated depreciation
(924,580 / 6 years) 154,097

Lease modification – extension of lease term

On January 1, 2020, an entity entered into lease for office space with the following information:

Annual rental payable at the end of each year

beginning December 31, 2020 200,000
Lease term 5 years
Implicit rate in the lease 9%
Present value of an ordinary annuity of 1 for 5 period at 9% 3.89

On January 1, 2022, the entity and the lessor to amend the original lease by extending the lease term by 3 more years
with the following information:

Annual rental payable at end of each

year beginning December 31, 2022 200,000
Implicit rate in the lease at 9% 11%
Present value of an ordinary annuity of 1 at 11% for 6 periods. 4.231

Amortization schedule for 2020 and 2021

Present value of the lease liability on

January 1,2020 (200,000 x 3.89) 778,000

Date Payment 9% Interest Principal Lease Liability

Jan. 1, 2020 778,000
Dec. 31, 2020 200,000 70,020 129,980 648,020
Dec. 31, 2021 200,000 58,322 141,678 506,342

Journal entries for 2020

Jan. 1 Right of use asset 778,000

Lease liability 778,000

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Dec. 31 Interest expense 70,020
Lease liability 129,980
Cash 200,000

31 Depreciation 155.600
Accumulated depreciation 155.600
(778,000 x 5)

New lease liability due to extension

Present value of lease payment on January 1, 2022

as a result of the extension (200,000 x 4.231) 846,200
Carrying amount on January 1, 2022
before the extension – see schedule (506,342)
Increase in lease liability 339,858

Revised amortization schedule

Date Payment 11% Interest Principal Lease Liability

Jan. 1, 2022 846,200
Dec. 31, 2022 200,000 93,082 106,918 739,282
Dec. 31, 2023 200,000 81,321 118,679 620,603
Dec. 31, 2024 200,000 68,226 131,734 488,869
Dec. 31, 2025 200,000 53,776 146,224 342,645
Dec. 31, 2026 200,000 37,691 162,309 180,336
Dec. 31, 2027 200,000 19,664 180,336 -

Journal entries for 2022

Jan. 1 Right of use asset 339,858
Lease liability 339,858

Dec. 31 Interest expense 93,082

Lease Liability 106,918
Cash 200,000

31 Depreciation 134,443
Accumulated depreciation 134.443

Cost of right use asset 778,000

Accumulated depreciation – December 31, 2021
(155,600 x 2 years) (311,200)
Carrying amount – December 31, 2021 466,800
Increase of liability 339,858
Adjusted carrying amount – January 1, 2022 806,658

The increase in liability is an adjustment of the carrying amount of the right of use asset.

Old lease term 5 years

Expired 2020 and 2021 2

Remaining old lease term 3

Extension 3

Extended lease term 6 years

Depreciation for 2022 (806,658/6) 134,443

Lease modification - decrease in scope of lease

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On January 1, 2020, an entity entered into a lease of office space with the following information:

Floor space 800 square meters

Annual rental payable at the end of each year 40,000
Lease term 10 years
Implicit rate in the lease 8%
Present value of an ordinary annuity of 1 for 8% for 10 periods 6.7101
Present value of lease payments – January 1, 2020 (40,000 x 6.7101) 268,404

Table of amortization for 2020 and 2021

Date Payment 8% Interest Principal Lease Liability

Jan. 1, 2020 268,404
Dec. 31, 2020 40,000 21,472 18,528 249,876
Dec. 31, 2021 40,000 19,990 20,010 229,866

Journal entries for 2020

Jan. 1 Right of use asset 268,404

Lease liability 268,404

Dec. 31 Interest expense 21,472

Lease Liability 18,528
Cash 40,000

31 Depreciation (268,404/10) 26,840

Accumulated depreciation 26,840

Amendment of the lease

On January 1, 2022, the lessee and the lessor agreed to amend the original term of the lease with the following
information:

Floor space 480 square meters

Annual rental payable at the end of each year 30,000
Implicit rate in the lease 10%
Present value of an ordinary annuity of 1 at 10% for 8 periods 5.3349

Decrease in scope

Since the floor space was reduced to 480 square meter, the scope of the lease was reduced by 40%.

IFRS 16, paragraph 46, states that a gain of loss should be recognized as a result of the partial termination of the lease.

If the decrease in carrying amount of lease liability is higher than the decrease in carrying amount of right of use asset,
the difference is a termination gain.

If the decrease in carrying amount of right of use asset is higher than the decrease in carrying amount of lease liability,
the difference is a termination loss.

Decrease in carrying amount of lease liability

(229,866 x 40%) 91,946
Decrease in carrying amount of right of use asset
(214,724 x 40%) ( 85,890)
Termination gain 6,056

Cost of right of use asset 268,404

Accumulated depreciation – December 31, 2021 (26,840 x 2) ( 53,680)
Carrying amount – December 31, 2021 214,724

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Lease liability – January 1, 2022 (see table) 229,866
Reduction of old lease liability ( 91,946)
Remaining old lease liability – January 1, 2022 137,920

Present value of lease payments on January 1, 2022

as a result of the decrease in scope (30,000 x 5.3349) 160,047
Carrying amount of old lease liability on
January 1, 2022 (137,920)
Increase in liability 22,127

The increase in lease liability as a result of the lease modification is an adjustment to the carrying amount of right of
use asset.

Revised table of amortization

Date Payment 10% Interest Principal Lease Liability

Jan. 1, 2022 160,047
Dec. 31, 2022 30,000 16,005 13,995 146,052
Dec. 31, 2023 30,000 14,605 15,395 130,657
Dec. 31, 2024 30,000 13,066 16,934 113,723
Dec. 31, 2025 30,000 11,372 18,628 95,095
Dec. 31, 2026 30,000 9,512 20,490 74,605
Dec. 31, 2027 30,000 7,461 22,539 52,066
Dec. 31, 2028 30,000 5,207 24,793 27,273
Dec. 31, 2029 30,000 2,727 27,273 -

Accumulated Carrying
Cost depreciation amount
Right of use asset 268,404 53,680 214,724
Reduction by 40% (107,362) ( 21,472) (85,890)
Balance 161,042 32,208 128,834
Increase in lease liability 22,127 - 22,127
Adjusted balance 183,169 32,208 150,961

Journal entries for 2022

Jan. 1 Lease liability 91,946

Accumulated depreciation 21,472
Right of use asset 107,362
Termination gain 6,056

1 Right of use asset 22,127

Lease liability 22,127

Dec. 31 Interest expense 16,005

Lease liability 13,995
Cash 30,000

Depreciation 18,870
Accumulated depreciation
(150,961 / 8 years remaining) 18,870
Lease modification – change in rental

On January 1,2020, an entity leased equipment with the following information:

Annual rental payable at the end of each year 80,000

Lease term 6 years
Implicit rate in the lease 7%

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Present value of an ordinary annuity of 1 at 7% for 6 periods 4.7665
Present value of lease payments – January 1, 2020 (80,000 x 4.7665) 381,320

Table of amortization

Date Payment 7% Interest Principal Lease Liability

Jan. 1, 2020 381,320
Dec. 31, 2020 80,000 26,692 53,308 328,012
Dec. 31, 2021 80,000 22,961 57,039 270,973
Dec. 31, 2022 80,000 18,968 61,032 209,941

Journal entries for 2020

Jan. 1 Right of use asset 381,320

Lease liability 381,320

Dec. 31 Interest expense 26,692

Lease liability 53,308
Cash 80,000

31 Depreciation (381,320/6) 63,553

Accumulated depreciation 63,553

Amendment of the lease

On January 1, 2023, the entity and the lessor agreed to amend the original term of the lease by reducing the lease
payment at P70,000 and increasing the implicit rate to 9%.

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

Computation

Modified lease liability – January 1, 2023

(70,000 x 2.5313) 177,191
Carrying amount of lease liability - January 1, 2023 (209,941)
Decrease in lease liability (32,750)

The decrease in liability is a reduction in the carrying amount of the right of use asset.

Cost of the right of use asset 381,320

Accumulated depreciation (63,553 x 3) (190,659)
Carrying amount – January 1, 2023 190,661
Decrease in lease liability (32,750)
Adjusted carrying amount – January 1, 2023 157,911

Revised amortization schedule

Date Payment 9% Interest Principal Lease Liability

Jan. 1, 2023 177,191
Dec. 31, 2023 70,000 15,947 54,053 123,138
Dec. 31, 2024 70,000 11,082 58,918 64,220
Dec. 31, 2024 70,000 5,780 64,220 -

Journal entries for 2023

Jan. 1 Right of use asset 32,750
Lease liability 32,750

Dec. 31 Interest expense 15,947

Lease liability 54,053
Cash 70,000

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 31 Depreciation 52,637
Accumulated depreciation 52,637
(157,911/3 years remaining)

References

Valix, C. & Valix, C.A. (2018). Practical Accounting 1 vol 2. GIC Enterprises and Co., Inc. Manila, Philippines

Valix, C. & Valix, C.A. (2013). Theory of Accounts 2013 edition. GIC Enterprises and Co., Inc. Manila, Philippines

Valix, C. Valix, C.A. (2019). Financial Accounting and Reporting vol 2. GIC Enterprises and Co., Inc. Manila,
Philippines

Robles, N. & Empleo P. (2016). The Intermediate Accounting Series Vol 2. Millenium Books, Inc., Mandaluyong City

Uberita, C. (2012). Practical Accounting 1 2013 Edition. GIC Enterprises and Co, Inc. Manila, Philippines

Testbanks and CPA Examination Reviewers

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