Problem 5 – Rental income

The following are independent situations regarding the lease of land owned by Mangosteen Company,
Inc. to Gumamela Corporation:

Situation A On January 1, 20A1, Mangosteen leased its land to Gumamela for a period of 15 years for
P2,000,000 monthly. Mangosteen also charged Gumamela real property tax (RPT) on the land for
P50,000 monthly. Gumamela constructed a building on said land. The building was completed on
October 1, 20A1 with total construction costs of P15,000,000, which represents its fair market value at
the time of completion. The building will be transferred to Mangosteen at the end of the lease term. The
building had an estimated useful life of 40 years. The lease continued for 15 years and the building was
transferred to Mangosteen at the end of the lease term.

Situation B On January 1, 20A1, Mangosteen leased its land to Gumamela for a period of 15 years for
P2,000,000 monthly. Mangosteen also charged Gumamela real property tax (RPT) on the land for
P50,000 monthly. Gumamela constructed a building on said land. The building was completed on
October 1, 20A1 with total construction costs of P15,000,000, which represents its fair market value at
the time of completion. The building will be transferred to Mangosteen at the end of the lease term. The
building had an estimated useful life of 40 years. However, Gumamela terminated the lease on
September 30, 20A8. It paid penalty of P1,200,000 for the termination of the contract.

Required: Determine the annual gross income that will be reported by Mangosteen for the entire term
of the lease under the two allowable methods in recognizing income.

Situation A

Under Outright Method for Leasehold Improvement:

Annual actual payment (2,000,000 x 12) P24,000,000

Annual Real Property Tax charge to lessee (50,000 x 12) 600,000
Annual Gross Income per year P24,600,000

Annual Gross Income P24,600,000

FMV of Building upon completion 15,000,000
Gross Income for the year 20A1 P39,600,000

Under Spread-Out Method for Leasehold Improvement:

Annual actual payment (2,000,000 x 12) P24,000,000

Annual Real Property Tax charge (50,000 x 12) 600,000
Annual Gross Income before Leasehold Improvement P24,600,000
Annual Income from Leasehold Improvement:
Cost of Leasehold P15,000,000
Depreciation for the remaining of the lease (15,000,000/40 x 14 ¼) 5,343,750
Book Value, end of lease 9,656,250
Remaining Lease Term (Divided by) 14 ¼ 677,631.58
Annual Gross Income per year P25,277,631.58
Annual Income from Leasehold Improvement for 20A1 (677,631.58 x 3/12) P169,407.90
Annual Gross Income before Leasehold Improvement 24,600,000
Gross Income for the year 20A1 P24,769,407.90

Situation B:

Under Outright Method for Leasehold Improvement:

Annual actual payment (2,000,000 x 12) P24,000,000

Annual Real Property Tax charge to lessee (50,000 x 12) 600,000
Annual Gross Income per year(20A2-2015) P24,600,000

Annual Gross Income P24,600,000

FMV of Building upon completion 15,000,000
Total Lease/Gross Income for 20A1 P39,600,000

Lease Income from Jan-Sept 20A8 (2,000,000 x 9) 18,000,000

Real Property Tax from Jan-Sept 20A8 (50,000 x 9) 450,000
Penalty payment 1,200,000
Income reported 20A8 19,650,000

Under Spread-Out Method for Leasehold Improvement:

Annual actual payment (2,000,000 x 12) P24,000,000

Annual Real Property Tax charge (50,000 x 12) 600,000
Total Annual Lease Income for the rest of the term P24,600,000
Annual Income from Leasehold Improvement:
Cost of Leasehold P15,000,000
Depreciation for the remaining of the lease (15,000,000/40 x 14 ¼) 5,343,750
Book Value, end of lease 9,656,250
Remaining Lease Term (Divided by) 14 ¼ 677,631.58
Annual Gross Income per year P25,277,631.58

Book Value of the building on the 20A8 (since no FMV) (15,000,000 – (375,000 x 7 yrs)) P12,375,000
Income recognize from Leasehold Improvement (20A1) (169,407.90)
Total Income recognize from Leasehold Improvement 20A2-20A7 (677,631.58 x 6) (4,065,789.48)
Income recognized in the 20A8 Year P8,139,802.62

Lease Income from Jan-Sept 20A8 (2,000,000 x 9) 18,000,000

Real Property Tax from Jan-Sept 20A8 (50,000 x 9) 450,000
Penalty payment 1,200,000 19,650,000
Income reported 20A8 P27,789,802.62