ACC226 PFRS

MODULE 1 OPERATING LEASE - LESSOR

o Lessor accounting under IFRS 16 is substantially unchanged from the old lease
standard under IAS 17.
o IFRS 16, par. 61, provides that a lessor shall classify leases as either an
operating lease or a finance lease.

Operating Lease Finance Lease

a lease that does not transfer a lease that transfers substantially all the
substantially all the risks and rewards risks and rewards incidental to ownership
incidental to ownership of an underlying of an underlying asset
asset.

When is a lease classified as finance lease?

a. transfers ownership
b. option to purchase – lower than FV
c. major part of the economic life - if the title is not transferred
o Major part means at least 75% of the economic life of an asset (USA GAAP).
d. All the FV of asset – equal to present value of the lease payments amounts
Other criteria – Suggestive
a. The underlying asset is of such specialized nature that only the lessee can use it
without major modification.
b. If the lessee can cancel the lease, the lessor’s losses associated with the
cancelation are borne by the lessee.
c. Gains or losses from the fluctuation in the fair value of the residual accrue to the
lessee.
d. The lessee can continue the lease for a secondary period at a rent that is
substantially lower that market rent.
Land and building lease
o The land and building elements separately
o Relative fair value
o If cannot be allocated reliably - finance lease, unless both elements are operating
lease.
If the land element is immaterial, treat land and building as single unit.
1) Lease payments – rent income either on a straight-line basis or another systematic
basis.

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 Cash xxx
Rent income xxx

2) Executory costs – lessor; however, it may pass on to lessee

Executory cost xxx
Cash xxx
3) Initial direct cost – added to the CA of the underlying asset and recognized as an
expense over the lease term on the same basis as lease income.
I. Initial Entry
Deferred initial direct cost xxx
Cash xxx
II. Amortization
Amortization of initial cost xxx
Deferred initial direct cost xxx
o Security deposit – refundable upon lease expiration.
Cash xxx
Liability for rent deposit xxx
o Lease bonus – unearned rent income to be amortized over the lease term.
I. Initial Entry
Cash xxx
Unearned rent income xxx
II. Amortization
Unearned rent income xxx
Rent income xxx
o Unequal rental payments
The total cash payments for the lease term shall be amortized uniformly on the
straight-line basis as rent income over the lease term.
QUIZ
1) Rent received in advance by the lessor in an operating lease should be recognized
as revenue
a. When received
b. At the lease inception
c. At the lease expiration
d. In the period specified by the lease

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2) When should a lessor recognize in income a nonrefundable lease bonus paid by a
lessee?
a. When received
b. At the inception of the lease
c. At the lease expiration
d. Over the lease term
3) Lease payments under an operating lease shall be recognized as an income by the
lessor on
a. Straight line basis over the lease term
b. Diminishing balance basis
c. Sum of units basis
d. Cash basis
4) In an operating lease that is recorded by the lessor, the equal monthly rental
payments should be
a. Recorded as reduction of depreciation
b. Allocated between reduction in lease receivable and interest expense
c. Recorded as reduction in the lease receivable
d. Recorded as a rental income
5) Which statement characterizes an operating lease?
a. The lessee records depreciation and interest
b. The lessee records a lease obligation
c. The lessor transfers title of the underlying asset to the lessee for the duration of
the lease term
d. The lessor records depreciation and lease revenue.
6) The classification of a lease is normally carried out
a. At the end of the lease term
b. After a "cooling off period of one year
c. At the inception of the lease
d. When the entity deems it to be necessary
7) The classification of a lease as either operating or finance lease is based on
a. The length of the lease
b. The transfer of the risks and rewards of ownership
c. The lease payments being at least 50% of fair value
d. The economic life of the underlying asset.
8) All of the following situations would prima facie lead to a lease being classified as a
finance lease, except
a. Transfer of ownership to the lessee
b. Option to purchase at a value below the fair value of the underlying asset
c. The lease term is for a major part of the asset's life
d. The present value of the lease payments is 50% of the fair value of the
asset.
9) In case of lease of land and building, the lease payments should be split
a. According to relative fair value of the two elements

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 b. Based on the useful life of the two elements
c. Using the sun of digits method
d. According to method devised by the entity
10)Where there is a lease of land and building and the title of the land is not
transferred, generally the lease is treated as if
a. The land is finance lease
b. The land is finance, and the building is operating
c. The land is operating, and the building is finance
d. The land and building are an operating lease.

Problems
11) Conn Company owns an office building and normally charges tenants P 3,000 per
square meter per year for office space. Because the occupancy rate is low, Conn
Company agrees to lease 1,000 square meters to Hanson Company at P 1,200 per
square meter for the first year of a three-year operating lease. Rent for remaining
years will be at the P 3,000 rate. Hanson Company moved into the building on
January 1, 2020, and paid the first year's rent in advance. What amount of rental
revenue should be reported in the income statement for the year ended September
30, 2020?

12)Wall Company leased an office to Fox Company for a five-year term beginning
January 1, 2020. Under the terms of the operating lease, rent for the first year is P
800,000 and rent for years 2 through 5 is P 1,250,000 per annum. However, as an
inducement to enter the lease, Wall Company granted Fox Company the first six
months of the lease rent-free. What amount should be reported as rental income
for 2020?

13)On January 1, 2020, Abba Company leased a building to Bee Company under a
four-year operating lease. The monthly rental for 2020, 2021, 2022, and 2023 is
P100,000, P 150,000, P 200,000 and P 250,000, respectively. Rentals are payable
at the end of each month. All rental payments within the year were made when
due. What amount should be reported as rent receivable from Bee Company on
December 31, 2021?

14)Abe Company, 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: January 1, 2020 January 1, 2021 January
1, 2022 January 1, 2023 1,000,000 1,000,000 1,400,000 1,700,000 1,900,000
January 1, 2024 On December 31, 2021, what amount should be reported as rent
receivable?

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 15)At the beginning of current year, Wren Company leased a building to Brill Company
under an operating lease for ten years at P 500,000 per year, payable the first day
of each lease year. Wren Company paid P 150,000 to a real estate broker as initial
direct cost. The building is depreciated P 120,000 per year. Wren Company
incurred insurance and property tax expense totaling P 90,000 for the current year.
What is the net rent income for the current year?
Solutions:
11. 1,000 x 1,200 = 1,200,000
1,000 x 3,000 = 3,000,000
1,000 x 3,000 = 3,000,000
7,200,000/3 = 2,400,000
1st year 2,400,000 x 9/12 = 1,800,000

12. 800,000 x 6/12 = 400,000

1,250,000 x 4 = 5,000,000
5,400,000/5 = 1,080,000

13. 100,000 x 12 = 1,200,000

150,000 x 12 = 1,800,000
200,000 x 12 = 2,400,000
250,000 x 12 = 3,000,000
8,400,000/4 = 2,100,000
Rent Income 4,200,000
Less: Rent collected 3,000,000
Rent Receivable 1,200,000

14. 1,000,000
1,000,000
1,400,000
1,700,000
1,900,000
7,000,000/5 = 1,400,000 x 2 = 2,800,000 – 2,000,000 = 800,000

15. 500,000
150,000/10 (15,000)
485,000
(120,000)
(90,000)
275,000

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 MODULE 2 LESSEE ACCOUNTING
DEFINITION OF LEASE
o IFRS 16 is the new lease standard.
o Lease is a contract or part of a contract that conveys the right to use the underlying
asset for a period in exchange for consideration.
Underlying asset
 is the subject of a lease for which the right to use that asset has been
provided by the lessor to the lessee.
Lessee
 is the entity that obtains the right to use an underlying asset. Lessor – is the
entity that provides the right to use an underlying asset.
o At the commencement date, a lessee shall recognize a right of use asset and a
lease liability.
o All leases shall be accounted for by the lessee as a finance lease under the new
lease standard.
Operating lease model for lessee
Two optional exemptions:
a. Short-term lease - 12 months or less
- with purchase option is not a short-term lease
b. Low value lease - new lease standard does not provide for a quantitative
threshold
- based on professional judgment
o Lease payments = rent expense (in either a straight-line basis or another systematic
basis).
Finance lease - Lessee
 defined as a lease that transfer all the risk and rewards incidental to
ownership of an underlying asset.
Initial measurement of right of use asset
Right of use asset
 defined as an asset that represents the right of a lessee to use an underlying
asset over the lease term in a finance lease.
 Measured at cost at commencement date.
Subsequent measurement of right of use asset
o IFRS 16, par 29, provides that a lessee shall measure the right of use asset applying
the cost model.

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o Cost less any accumulated depreciation and impairment loss
o Moreover, the CA of the right of use asset is adjusted for any remeasurement of the
lease liability
Presentation of right of use asset
o Separate line item in the statement of financial position.
o As an alternative, for example, the right of use asset related to equipment may be
included within PPE.
o However, disclosure is required that the PPE include right of use asset.
Other measurement models
o If the lessee applies the FV model in measuring investment property, the lessee
shall apply the FV model to the right of use asset that meets the definition of
investment property.
o If the right of use assets relates to a class of PPE to which the lessee applies the
revaluation model, a lessee may elect to apply the revaluation model to all the right
of use assets that relate to that class of PPE.
Depreciation of right of use asset
o Useful life of the underlying asset under the following conditions.
a. The lease transfer 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.
o Otherwise, the lessee shall depreciate the right of use asset over the shorter
between the useful life of the asset and the lease term.
Measurement of Lease Liability
o At the commencement date, the lessee shall measure the lease liability at the
present value of lease payments.
o Discounted using the interest rate implicit in the lease.
o If cannot be readily determine, the incremental borrowing rate of the lessee is used.
Components of lease payments
a. Fixed lease payments less any lease incentives
b. Variable lease payments
c. Exercise price of a purchase option if the lessee is 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
plan.
Other definitions
Residual value guarantee

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  is the guarantee made to the lessor by a party unrelated to the lessor that the
value of an underlying asset at the end of the lease term will be at least a
specified amount.
Unguaranteed residual value
 is that portion of the residual value of the underlying asset, the realization of
which by the lessor is not assured or is guaranteed solely by a party related to
the lessor.
Executory costs
 are ownership expenses such as maintenance, taxes, and insurance for the
underlying asset.
 Such executory costs are expensed immediately when incurred.

QUIZ
1. Under IFRS, a lessee is required to recognize
a. Right of use asset and lease liability
b. Right of use asset but not lease liability
c. Lease liability but not right of use asset
d. Either right of use asset or lease liability
2. The lessee may apply the operating lease model under what condition?
a. Short-term lease
b. Low value lease
c. Both short-term lease and low value lease
d. Under all circumstances
3. A short-term lease is defined as
a. Twelve months or less
b. Six months or less
c. Twelve-month lease with a purchase option
d. Two-year lease with option to terminate
4. Which statement is true about low value lease?
a. The value of an underlying asset is based on the value of the asset when
new regardless of the age of the asset.
b. The term of a low value lease may be more than twelve months.
c. An underlying asset does not qualify as low value lease if the nature of the asset
is such that the asset is typically not of low value when new.
d. All these statements are true about low value lease.
5. A right of use asset is initially measured at
a. Cost
b. Fair value
c. Current cost
d. Present value of expected cash inflows
6. The cost of right of use asset comprises all, except
a. The present value of lease payments
b. Lease payments made to lessor on or before commencement date

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 c. Initial direct cost incurred by lessee
d. Estimated cost of dismantling, removing, or restoring the underlying asset
for which the lessee has no present obligation
7. The right of use asset is reported as
a. Noncurrent as a separate line item
b. Property, plant, and equipment
c. Intangible asset
d. Investment Property
8. A lessee with a lease containing a purchase option that is reasonably certain to be
exercised should depreciate the right of use asset over
a. Useful life of the asset
b. Lease term
c. Useful life of the asset or the lease term, whichever is shorter
d. Useful life of the asset or the lease term, whichever is longer
9. A lease liability is measured at
a. The absolute amount of lease payments
b. The present value of lease payments
c. The present value of fixed lease payments
d. The fair value of the underlying asset
10. The lease payments include all the following, except
a. Fixed lease payments
b. Leasehold improvement
c. Exercise price of a purchase option that is certain to be exercised
d. Residual value guarantee of the lessee
Problems
11. At the beginning of current year, East Company leased a new machine from North
Company with the following information:
Annual rental payable at beginning of each lease year 400,000
Lease term 10 years
Useful life of machine 12 years
Implicit interest rate 14%
Present value of an annuity of 1
in advance for 10 periods at 14% 5.95
Present value of 1 for 10 periods at 14% 0.27
East Company has the option to purchase the machine upon the expiration of the
lease term by paying P500,000. The purchase option is reasonably certain to be
exercised. What is the initial cost of the right of use asset to be recognized by East
Company?

12-14
At the beginning of current year, Ashe Company entered a ten-year noncancelable
lease requiring year-end payments of P 1,000,000. Ashe's incremental borrowing
rate is 12%, while the lessor's implicit interest rate, known to Ashe, is 10%. Present
value factors for an ordinary annuity for ten periods are 6.145 at 10%, and 5.650 at

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 12%. On the same date, Ashe Company paid initial direct cost of P 200,000 in
negotiating and securing the leasing arrangement. Ownership of the property
remains with the lessor at expiration of the lease. The leased property has an
estimated economic lite of 12 years.
12. What amount should be capitalized as the right of use of asset?

13. What is the depreciation for the current year?

14. What is the lease liability at the end of current year?

15. At the beginning of current year, Nori Company entered a year lease for drilling
equipment. The entity accounted for the acquisition as a finance lease for P
2,400,000, which included a P100,000 purchase option. At the commencement date,
the entity is reasonably, certain to exercise the purchase option. The entity estimated
that the equipment's fair value will be P 200,000 at the end of the 8-year life and
regularly used straight line depreciation on similar equipment. What amount should
be recognized as depreciation expense on the leased asset for the current year?

16. At the beginning of current year, Janette Company entered an 8-year lease for an
equipment. The entity accounted for the acquisition as a finance lease for P
6,000,000 which included a P 600,000 residual value guarantee. At the end of the
lease, the asset will revert to the lessor. It is estimated that the fair value of the asset
at the end of the 10-year useful life would be P400,000. The entity used the straight-
line depreciation. What amount should be recognized as depreciation expense of the
right of use asset for the current year?

17. Oak Company leased equipment for the entire nine-year useful life, agreeing to pay
P 500,000 at the start of the lease term on December 31, 2020 and P 500,000
annually on each December 31 for the next eight years. The present value on
December 31, 2020, for the nine lease payments over the lease term, using the rate
implicit in the lease which Oak Company knows to be 10%, was P 3,165,000. The
December 31, 2020, present value of the lease payments using the incremental
borrowing rate of 12% was P 2,980,000. What amount should be reported as lease
liability on December 31, 2021?

18. On January 2020, Blaugh Company signed a long-term lease for an office building.
The terms of the lease required Blaugh Company to pay P 100,000 annually,
beginning December 31, 2020, and continuing each year for 30 years. On January
1, 2020, the present value of the lease payments is P 1,126,000 at the 8% interest
rate implicit in the lease. What amount should be reported as lease liability on
December 31, 2020?

19. On December 31, 2020, Rafferty, Company leased equipment under a finance lease.
Annual lease payments of P 200,000 are due December 31 for 10 years. The
equipment useful life is 10 years, and the interest rate implicit in the lease is 10%.
The lease obligation was recorded on December 31, 2020 at P 1,350,000 and the

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 first lease payment was made on that date. What amount should be included in
current liabilities on December 31, 2020, in relation to the lease?

20. Candon Company leased many assets and capitalized most the leased assets. On
December 31, 2020, the entity had the following balances in relation to a leased
equipment:
Right of use asset 4,000,000
Accumulated depreciation 2,450,000
Lease liability 1,300,000
Depreciation has been recorded up to the end of the current year and no accrued
interest is involved. On December 31, 2020, the entity decided to purchase the
equipment for P 1,600,000 cash. What is the cost of the actual purchase of the
leased equipment?
Solutions
11. 400,000 x 5.95 = 2,380,000
500,000 x 0.27 = 135,000
2,515,000
12. 1,000,000 x 6.145 = 6,145,000
200,000
6,345,000
13. 6,345,000/10 = 634,500
14.
15. 2,400,000 – 200,000 = 2,200,000/8 = 275,000
16. 675,000
17. PV 3,165,000
(500,000)
2,665,000
500,000
266,000 (233,500)
2,431,000
18. 1,116,080
19. 85,000
20. 1,850,000

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QUIZ 2
12.
13.
14. 100,000 x 51 = 5,100,000/5 = 1,020,000

MODULE 3 DIRECT FINANCE LEASE – LESSOR

Finance lease classification
o On the part of the lessor, a finance lease is either:
a. Direct finance lease - recognizes only interest income.
b. Sales type lease - recognized interest income and gross profit on sale
o The main distinction between the two is the presence or absence of a manufacturer
or dealer profit or loss.
Accounting considerations
a. Gross investment – Gross rentals for the entire lease term plus RV, whether
guaranteed or unguaranteed.
b. Net investment in the lease – cost of the asset plus IDC paid by the lessor.
c. Unearned interest income - difference between a and b.
d. Initial direct cost – added to the cost of the asset.

MODULE 4 SALES TYPE LEASE – LESSOR

Introduction
o The lessor is actually a manufacturer or dealer that uses the lease as a means of
facilitating the sale of product.
o Interest income and recognition of a manufacturer or dealer profit

Accounting considerations
a. Gross investment – Gross rentals for the entire lease term plus RV, whether
guaranteed or unguaranteed.
b. Net investment in the lease – PV of the gross rentals plus the present value of
the RV, whether guaranteed or unguaranteed.
c. Unearned interest income - difference between a and b.
d. Sales – Net investment in the lease or fair value of the asset, whichever is lower
e. Cost of goods sold – cost of the asset sold plus the initial direct cost paid by the
lessor.
f. Gross profit – Sales minus cost of goods sold.

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 g. Initial direct cost – component of COGS

MODULE 5 SALE AND LEASEBACK

Sale and Leaseback

 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
Illustration: Sales price at FV On January 1, 2017, an entity sold an equipment with
remaining life of 10 years and immediately leased it back for 4 years at the prevailing
market rentals
Sale Price at Fair Value
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%
PVOA 1 at 10% for four periods 3.170
Compute for:
a. Lease liability
b. Right of use asset
c. Gain or loss to be recognized

Present value of rentals (800,000 x 3.17) 2,536,000

Sale price at fair value 6,000,000
Carrying amount of equipment 4,500,000
Cost of Right of use asset = PV of LL / FV x CA
Cost of Right of use asset
(2,536,000 / 6,000,000 x 4,500,000) 1,902,000

Gain or loss to be recognized

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Gain or loss
 pertain to the right retained by the sellerlessee is not recognized.
 pertains to the right transferred to the buyerlessor is recognized.
Total gain = FV-CA (6M-4.5M) 1,500,000
Fair Value 6,000,000
Right retained by seller-lessee equal to LL 2,536,000
Right transferred to buyer-lessor 3,464,000
Gain to be recognized (3,464K / 6M x 1.5M) 866,000
Gain not to be recognized (2,536K / 6M x 1.5M) 634,000
Total gain 1,500,000
Sales Price above Fair Value
On January 1, 2017, an entity sold a building with remaining life of 20 years and
immediately leased it back for 5 years at the prevailing market rental.
Sale price 20,000,000
FV of Building 18,000,000
Carrying amount of building 10,000,000
Annual rental payable at the end of each year 1,500,000
Implicit interest rate 6%
PVOA 1 at 10% for four periods 4.212
Compute for:
a. Lease liability
b. Right of use asset
c. Gain or loss to be recognized

Lease Liability
Present value of rentals (1,500,000 x 4.212) 6,318,000

Right of use asset

Sale price 20,000,000

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Fair value of building 18,000,000
Excess sale price over fair value 2,000,000

PV of rentals 6,318,000
Additional financing equal to excess FV (2,000,000)
PV related to lease liability 4,318,000

Cost of Right of use asset = PV of LL / FV x CA

Cost of Right of use asset
(4,318,000 / 18,000,000 x 10,000,000) 2,398,889

Gain or loss to be recognized

Total gain = FV-CA (18M-10M) 8,000,000

Fair Value 18,000,000

Right retained by seller-lessee equal to LL 4,318,000
Right transferred to buyer-lessor 13,682,000

Gain to be recognized (13,682K / 18M x 8M) 6,080,889

Gain not to be recognized (4,318K/18Mx8M) 1,919,111
Total gain 8,000,000

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 Sales Price below Fair Value
Illustration: Sales price below FV On January 1, 2017, an entity sold an equipment with
remaining life of 8 years and immediately leased it back for 5 years.
Sale price 5,000,000
FV of Equipment 5,500,000
Carrying amount of equipment 4,000,000
Annual rental payable at the end of each year 900,000
Implicit interest rate 8%
PVOA 1 at 8% for five periods 3.993
Compute for:
a. Lease liability
b. Right of use asset
c. Gain or loss to be recognized

Lease Liability
Present value of rentals (900,000 x 3.993) 3,593,700

Right of use asset

Fair value of building 5,500,000
Sale price 5,000,000
Excess sale price over fair value 500,000

PV of rentals 3,593,700
Additional financing equal to excess FV 500,000
PV related to lease liability 4,093,700

Cost of Right of use asset = PV of LL / FV x CA

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Cost of Right of use asset
(4,093,700 / 5,500,000 x 4,000,000) 2,977,236

Gain or loss to be recognized

Total gain = FV-CA (5.5M-4M) 1,500,000

Fair Value 5,500,000

Right retained by seller-lessee equal to LL 4,093,700
Right transferred to buyer-lessor 1,406,300

Gain to be recognized (1,406.3K/5.5M x1.5M) 383,536

Gain not to be recognized (4,093.7K/5.5Mx1.5M) 1,116,464
Total gain 1,500,000

Sales price at FV with loss

Illustration: Sales price at FV with loss
On January 1, 2017, an entity sold a building with remaining life of 25 years and
immediately leased it back for 3 years.
Sale price at FV 10,000,000
Carrying amount of equipment 12,000,000
Annual rental payable at the end of each year 500,000
Implicit interest rate 8%
PVOA 1 at 8% for three periods 2.577
Compute for:
a. Lease liability
b. Right of use asset
c. Gain or loss to be recognized
Lease Liability
Present value of rentals (500,000 x 2.577) 1,288,500
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Right of use asset
Carrying amount 12,000,000
Sale price at fair value 10,000,000
Cost of Right of use asset = PV of LL / FV x CA
Cost of Right of use asset
(1,288,500 / 10,000,000 x 12,000,000) 1,546,200
Gain or loss to be recognized
Total loss = FV-CA (10M-12M) 2,000,000
Fair Value 10,000,000
Right retained by seller-lessee equal to LL 1,228,500
Right transferred to buyer-lessor 8,771,500
Loss to be recognized (8,771.5K/10M x2M) 1,742,300
Loss not to be recognized (1,228.5K/10Mx2M) 257,700
Total gain 2,000,000

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