CHAPTER 3
LEASE ACCOUNTING
1. On January 1, 2020, an entity leased a machinery for 4 years which is the same as the useful life
of the machinery at annual rental or fixed payment of P100,000 payable at the end of each year.
The lease provides for a transfer of ownership of the underlying asset to the lessee at the end of
the lease term.
a. Prepare journal entry to record the finance lease at the commencement date of the lease.
b. Prepare journal entry to record the annual depreciation of the right of use asset.
c. Prepare the table of amortization for the lease liability.
d. Prepare journal entry to record the annual payment for years 2020 and 2021.
Answer:
100,000 x 3.0373
Entry:
Right of use asset
Lease liability
303,730
Depreciation
Accumulated Depn
(303,730/4 years)
75,932
303,730
75,932
2020
Interest expense
Lease liability
Cash
36,448
63,552
2021
Interest expense
Lease liability
Cash
28,821
71,179
100,000
100,000
2. (Certain purchase option)
Lessee Company leased a machine on January 1, 2020 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 interest rate
12%
Present value of an ordinary annuity of 1 for 10 periods at
14%
5.216
12%
5.650
Present value of 1 for 10 periods at
14%
0.270
12%
0.322
Lessee Company has the option to purchase the machine upon the lease expiration on January 1,
2030 by paying P500,000. The lessee is reasonably certain to exercise the purchase option at the
1
commencement date of the lease. The estimated residual value of the machine at the end of the
12-year life is P600,000.
a. Compute the cost of right of use asset and prepare journal entry to record the
acquisition of the machinery under a finance lease.
b. Prepare journal entry to record the first rental payment on December 31, 2020.
c. Prepare journal entry to record the annual depreciation.
d. Prepare the table of amortization
e. If the purchase option is exercised on January 1, 2030, prepare the journal entry to
record the payment.
f. If the purchase option is not exercised, prepare the journal entry to recognize the loss
on finance lease.
Answer:
PV of lease payments (1M x 5.65)
PV of purchase options (500,000 x 0.322)
Total lease liability
5,650,000
161,000
5,811,000
Right of use asset
Lease liability
5,811,000
5,811,000
Interest expense
Lease liability
Cash
697,320
302,680
1,000,000
5,811,000 – (1M – 697,320)
Depreciation
Accumulated Depn
(5,211,000 / 12)
434,250
434,250
5,811,000 – 600,000
Exercise purchase option
Lease liability
Cash
500,000
500,000
Nonexercise of purchase option
Acc depn (434,250 x 10)
Lease liability
Loss on finance lease
Right of use asset
4,342,500
500,000
968,500
5,811,000
2
3. Residual value guarantee
Easy Company leased an equipment on January 1, 2020 with the following information:
Fixed rental payment at the end of each year
Lease term
Useful life of equipment
Implicit interest rate
Present value of an ordinary annuity of 1 for 4 periods at 10%
Present value of 1 for 4 periods at 10%
1,000,000
10 years
12 years
12%
3.16987
0.683
Easy Company guaranteed a P200,000 residual value on December 31, 2023 to the lessor. As
long as there is a residual value guarantee, there is no more purchase option because the
equipment will revert to the lessor upon the expiration of the lease on December 31, 2023.
a. Compute the initial cost of right of use and lease liability.
b. Prepare table of amortization of lease liability.
c. Compute for the lease liability as of December 31, 2020.
d. Prepare journal entry to record the (a) acquisition of the equipment; (b) first annual
payment on December 31, 2020; (c) annual depreciation.
e. Prepare journal entry to record the (a) final annual payment on December 31, 2023
and (b) the return of the equipment to the lessor.
Answer
PV of lease payments (1M x 3.16987)
PV of purchase options (200,000 x 0.683)
Cost of Right of Use Asset
3,169,870
136,600
3,306,470
Right of use asset
Lease liability
3,306,470
3,306,470
Interest expense
Lease liability
Cash
330,647
669,353
1,000,000
5,811,000 – (1M – 697,320)
Depreciation
Accumulated Depn
(3,306,470 – 200,000 / 12)
Final annual payment
Interest expense
Lease liability
Cash
Return of equipment
Acc Dep
Lease liability
Right of use asset
776,617
776,617
109,090
890,910
1,000,000
3,106,470
200,000
3,306,470
4. Initial direct cost
3
On January 1, 2020, Simple Company leased an equipment with the following information:
Annual fixed payment in advance at the beginning of each lease year
1,000,000
Initial direct cost paid
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 annuity of 1 in advance at 8% for 5 periods
4.3121
PV of 1 at 8% for 5 periods
0.6806
a. Compute the initial cost of right of use and lease liability.
b. Prepare table of amortization of lease liability.
c. Prepare journal entry to record the (a) acquisition of the equipment under a finance
lease; (b) the first payment on January 1, 2020; (c) accrual of the interest on
December 31, 2020; (d) depreciation for 2020.
d. Prepare journal entry to record the (a) second payment on January 1, 2021; (b)
accrual of interest on December 31, 2021; (c) depreciation for 2021.
e. Prepare journal entry to record the return of equipment to the lessor on January 1,
2025.
Answer
PV of lease payments (1M x 4,3121)
PV of purchase options (300,000 x 0.6806)
Lease liability
Lease incentives
Initial direct cost
Cost of Right of Use Asset
4,312,100
204,180
4,516,280
250,000
(150,000)
4,616,280
2020
Right of use asset
Lease liability
Cash
4,616,280
4,516,280
100,000
Lease liability
Cash
1,000,000
1,000,000
Interest expense
Accrued interest payable
281,302
Depreciation
Accumulated Depn
(4,616,280 – 300,000) / 5
863,256
2021
Accrued interest expense
Lease liability
281,302
863,256
281,302
718,698
4
Cash
1,000,000
Interest expense
Accrued interest payable
223,807
Depreciation
Accumulated Depn
(4,616,280 – 300,000) / 5
863,256
Return of equipment
Acc Dep (863,256 x 5)
Lease liability
Accrued interest payable
Right of use asset
223,807
863,256
4,316,280
277,748
22,252
4,616,280
5. Unguaranteed residual value
Ezzy Company leased a warehouse on January 1, 2020 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
224,000
PV of 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. Thus, the
equipment will revert to the lessor upon the expiration of lease on January 1, 2026.
a. Compute for the total cost of right of use asset
b. Prepare journal entry to record the (a) acquisition of the warehouse under a finance
lease; (b) payment of executory cost; (c) first rental payment on December 31, 2020
and (d) depreciation for 2020.
c. Prepare journal entry for January 1, 2026 return of the warehouse to the lessor.
Answer
PV of lease payments (600,000 x 4.36)
Payment to lessor to obtain a long-term lease
PV of restoration cost
Cost of Right of Use Asset
2,616,000
224,000
400,000
3,240,000
Right of use asset
Lease liability
Cash
Estimated liability for restoration
3,240,000
2,616,000
224,000
400,000
Executory cost
Cash
50,000
Interest expense (10% x 2,616,000)
Lease liability
Cash
261,600
338,400
Depreciation
Accumulated Depn
(3,240,000) / 6
540,000
Return to the lessor
Acc. Dep (540,000 x 6)
50,000
600,000
540,000
3,240,000
5
Equipment
3,240,000
6. Actual purchase of underlying asset
An entity purchased an equipment 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:
Right of use asset
5,000,000
Accumulated depreciation
1,500,000
Lease liability
3,800,000
a. Prepare journal entry to record the cost of equipment purchased.
Answer:
Right of use asset
Acc Dep
Carrying amount
Cash payment
Total consideration
Lease liability
Cost of equipment purchased
Equipment
Acc Dep
Lease liability
Right of use asset
Cash
5,000,000
(1,500,000)
3,500,000
4,000,000
7,500,000
(3,800,000)
3,700,000
3,700,000
1,500,000
3,800,000
5,000,000
4,000,000
7. 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 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, 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
a. Prepare the table of amortization.
b. Prepare journal entry for 2020 to record the (a) right of use asset; (b) annual
amortization (c) annual depreciation.
On January 1, 2023, the lease liability is remeasured using the new implicit interest rate
of 8%.
a.
b.
c.
d.
e.
Compute for the present value of remaining rental of old lease term
Compute for the present value of rentals of extended lease term.
Compute for the new carrying amount of the right of use asset.
Prepare the new table of amortization.
Prepare journal entry to record (a) remeasurement of lease liability on January 1,
2023 (b) annual rental on December 31, 2023 (c) annual depreciation based on the
new carrying amount.
Answer
PV of lease payments (50,000 x 3.791)
1,895,500
6
Right of use asset
Lease liability
1,895,500
1,895,500
Interest expense
Lease liability
Cash
189,550
310,450
500,000
5,811,000 – (1M – 697,320)
Depreciation
Accumulated Depn
(1,895,500 / 5)
379,100
379,100
Remeasurement of lease liability
PV – 1/1/23 (500,000 x 1.783) = 891,500
Annual rental starting 2025 (600,000 x 3.993 x 0.857) = 2,053,200
PV of remaining rentals of old lease term
PV of rentals of extended lease term
Total PV on 1/1/23
PV – 12/31/22
Increase in lease liability
891,500
2,053,200
2,944,700
(897,910)
2,076,790
Right of use asset – 1/1/20
Acc Dep (379,100 x 3 years)
Carrying amount – 12/31/22
Increase in liability – 1/1/23
New carrying amount – 1/1/23
1,895,500
(1,137,300)
758,200
2,076,790
2,834,990
7
Right of use asset
Lease liability
2,076,790
2,076,790
Interest expense
Lease liability
Cash
235,576
264,424
Depreciation
Accumulated Depn
(2,834,990 / 7)
404,999
500,000
404,999
8. Variable payments
On January 1, 2020, an entity 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.
a. Compute for the present value of annual rentals for three years.
b. Compute for the present value of annual rentals for next five years.
c. Compute for the lease liability as of January 1, 2020.
d. Prepare table of amortization.
e. Prepare journal entry to record (a) right of use asset; (b) annual rental payment (c)
annual depreciation.
Answer
PV of annual rental for 3 years (300,000 x 2.487) = 746,100
PV of annual rental for next 5 years (400,000 x 3.791 x 0.751) = 1,138,816
Total lease liability 1/1/20 = 1,884,916
Right of use asset
Lease liability
1,884,916
1,884,916
Interest expense
Lease liability
Cash
188,492
111,508
300,000
8
Depreciation
Accumulated Depn
(1,884,916 / 8)
235,615
235,615
9. Lease Modification
On January 1, 2020, an entity entered into a lease agreement with the following information:
Floor space
3,000 sq. mtrs
Annual rental payable at the end of each year
100,000
Implicit rate in the lease
10%
Lease term
8 years
PV 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 sq. mtrs
Increase in rental payable at the end of each year
200,000
Implicit rate in the lease
8%
PV of an ordinary annuity of 1 at 8% for 6 periods
4.6229
The increase in the rental for the additional 4,500 square meters is equivalent to the current
market value.
a. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2022.
Answer:
PV of lease payments 1/1/20 (100,000 x 5.3349) = 533,490
Right of use asset
Lease liability
533,490
Interest expense (533,490 x 10%)
Lease liability
Cash
53,349
46,651
Depreciation
Accumulated Depn
(533,490 / 8)
66,686
533,490
100,000
66,686
Modification
PV of the additional lease payment 1/1/22 (200,000 x 4.6229) = 924,580
Right of use asset
Lease liability
924,580
Interest expense (533,49 x 10%)
Lease liability
Cash
73,966
126,034
Depreciation
Accumulated Depn
(924,580 / 6 years)
154,097
924,580
200,000
154,097
9
10. Lease Modification (extension of lease term)
On January 1, 2020, an entity entered into a lease for office space with the following information:
Annual rental payable at the end of each year beginning Dec 31, 2020
200,000
Lease term
5 years
Implicit rate in the lease
9%
PV of an ordinary annuity of 1 for 5 periods at 9%
3.89
On January 1, 2022, the entity and the lessor agreed to amend the original lease by extending the
lease term by 3 more years with the following information:
Annual rental payable at the end of each year beginning Dec 31, 2022
200,000
Implicit rate in the lease
11%
PV of an ordinary annuity of 1 at 11% for 6 periods
4.231
a. Prepare amortization schedule for 2020 and 2021.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
c. Compute for the amount increase in lease liability.
d. Prepare the revised amortization schedule.
e. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2022.
Answer:
PV of lease liability on 1/1/20 (200,000 x 3.89) = 778,000
Right of use asset
Lease liability
778,000
Interest expense
Lease liability
Cash
70,020
129,980
Depreciation
Accumulated Depn
(778,000 / 5 years)
155,600
778,000
200,000
155,600
New lease liability due to extension
PV of lease payments om 1/1/22 as a result of the
extension (200,000 x 4.231)
Carrying amount on 1/1/22 before extension
Increase in lease liability
846,200
(506,342)
339,858
10
Right of use asset
Lease liability
339,858
Interest expense
Lease liability
Cash
93,082
106,918
Depreciation
Accumulated Depn
134,443
Cost of right of use asset
Acc Depn 12/31/21 (155,600 x 2)
Carrying amount – 12/31/21
Increase in lease liability
Adjusted carrying amount – 1/1/22
778,000
(311,200)
466,800
339,858
806,658
339,858
200,000
134,443
Extended lease term (5 – 2 + 3 = 6)
Annual depreciation (806,658 / 6) = 134,443
11. Lease Modification (decrease in scope of lease)
On January 1, 2020, an entity entered into a lease of office space with the following information:
Floor space
Annual rental payable at the end of each year
Lease term
Implicit rate in the lease
PV of an ordinary annuity of 1 for 8% for 10 periods
PV of lease payments – January 1, 2020 (40,000 x 6.7101)
800 sq mtrs
40,000
10 years
8%
6.7101
268,404
a. Prepare table of amortization for 2020 and 2021.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
Amendment of the lease
On January 1, 2022, the lessee and the lessor agreed to amend the original terms of the lease with
the following information:
Floor space
480 sq. mtrs
Annual rental payable at the end of each year
30,000
Implicit rate in the lease
10%
PV of an ordinary annuity of 1 at 10% for 8 periods
5.3349
11
c.
d.
e.
f.
Compute for the termination gain.
Compute for the carrying amount of old lease on Jan 1, 2022.
Prepare the revised table of amortization
Prepare necessary journal entries for 2022.
Answer
Before lease modification
Right of use asset
Lease liability
268,404
Interest expense
Lease liability
Cash
21,472
18,528
Depreciation (268,404 / 10)
Accumulated Depn
26,840
268,404
40,000
26,840
Decrease in scope
Decrease in carrying amount of lease liability
(229,866 x 40%)
Decrease in carrying amount of right of use asset
(214,724 x 40%)
Termination gain
91,946
Cost of right of use asset
Acc Deprn
Carrying amount – 12/31/21
268,404
(53,680)
214,724
Lease liability – 1/1/22
Reduction of old lease liability
Remaining old lease liability 1/1/22
229,866
(91,946)
137,920
PV of lease payments 1/1/2022 as a result of the
decrease in scope (30,000 x 5.3349)
Carrying amount of old lease liability on 1/1/22
Increase in lease liability
160,047
(85,890)
6,056
(137,920)
22,127
12
Lease liability
Acc Depn
Right of use asset
Termination gain
91,946
21,472
Right of use asset
Lease liability
22,127
Interest expense
Lease liability
Cash
16,005
13,995
Depreciation (150,961 / 8)
Accumulated Depn
18,870
107,362
6,056
22,127
30,000
18,870
12. Lease modification – change in rental
On January 1, 2020, an entity lease 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%
PV of an ordinary annuity of 1 at 7% for 6 periods
4.7665
PV of lease payments – January 1, 2020 (80,000 x 4.7665)
381,320
a. Prepare table of amortization for 2020 to 2021.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
Amendment of the lease
On January 1, 2023, the entity and the lessor agreed to amend the original terms of the lease by
reducing the lease payment to P70,000 and increasing the implicit rate to 9%. The present value
of an ordinary annuity of 1 at 9% for 3 periods is 2.5313.
c. Compute for the decrease in lease liability.
d. Compute for the adjusted carrying amount – January 1, 2023
e. Prepare necessary journal entries for 2023
Before lease modification
13
Right of use asset
Lease liability
381,320
Interest expense
Lease liability
Cash
26,692
53,308
Depreciation (381,320 / 6)
Accumulated Depn
63,553
381,320
80,000
63,533
Lease modification
Modified lease liability 1/1/23 (70,000 x 2.5313)
Carrying amount of lease liability
Decrease in lease liability
177,191
(209,941)
(32,750)
Cost of right of use asset
Acc Dep (63,553 x 3)
Carrying amount – 1/1/23
Decrease in lease liability
Adjusted carrying amount 1/1/23
381,320
(190,659)
190,661
(32,750)
157,911
Right of use asset
Lease liability
32,750
Interest expense
Lease liability
Cash
15,947
54,053
Depreciation (157,911 / 3)
Accumulated Depn
52,637
32750
70,000
52,637
14
13. Operating lease – Lessor
Prepare journal entries to the following transactions:
1.
On January 1, 2020, Simple Company purchased a machinery for P3,000,000 cash for
the purpose of leasing it. The machine is expected to have a 10-year life and no
residual value.
2.
3.
Machinery
3,000,000
Cash
3,000,000
On April 1, 2020, Simple Company leased the machine to another entity for 3 years at
a monthly rental of P50,000, payable at the beginning of every month.
Cash (50,000 x 9)
450,000
Rent Income
450,000
On April 1, 2020, Simple Company received a security deposit of P600,000 to be
refunded upon the lease expiration.
Cash
4.
600,000
Liability for rent deposit
600,000
In addition to the rental, Simple Company received from the lessee a lease bonus of
P120,000 on January 1, 2020.
Cash
5.
120,000
Unearned rent income
120,000
On April 1, 2020, Simple Company paid initial direct cost of P300,000. Such cost are
directly attributable to negotiating and arranging the operating lease.
6.
Deferred initial direct cost
300,000
Cash
300,000
During the year, Simple Company paid repair and maintenance of P20,000.
7.
Repair and maintenance
20,000
Cash
20,000
The lease bonus is amortized over 3 years or P40,000 annually.
8.
Unearned rent income
30,000
Rent income (40,000 x 9/12)
30,000
The machinery is depreciated over 10 years or P300,000 annually.
9
Depreciation
300,000
Acc Depn
300,000
The initial direct cost is recognized as expense over the lease term.
Amotn of initial direct cost
Deferred initial direct cost
(300,000 / 3 x 9/12)
75,000
75,000
14. Unequal rental payments
Aye Company lease office space to another entity for a three-year period beginning January 1,
202. Under the terms of the operating lease, rent for the first year is P1,000,000 and rent for the
next two years , P1,250,000 annually. However, as an inducement to enter the lease, Aye granted
the lessee the first six months of the lease rent-free.
a. Compute for the average annual rental.
b. Prepare cash collections for the year 2020, 2021 and 2022.
Answer:
(1,000,000 / 2) + 1,250,000 + 1,250,000 = 3,000,000
Ave Annual Rent = 3,000,000 / 3 = 1,000,000
2020
Cash
Rent Receivable
Rent income
500,000
500,000
1,000,000
15
2021
Cash
Rent Receivable
Rent income
1,250,000
250,000
1,000,000
2022
Cash
Rent Receivable
Rent income
1,250,000
250,000
1,000,000
15. Direct financing lease
On January 1, 2020, Lessor Company leased a machinery to another entity with the following
details:
Cost of machinery
Annual rental payable at the end of each year
Lease term
Useful life of machinery
Implicit interest rate
PV of annuity of 1 for 4 years at 12%
1,518,650
500,000
4 years
4 years
12%
3.0373
a. Compute for the lease receivable, cost of the machinery and unearned interest
income. Prepare also the corresponding journal entry.
b. Prepare journal entry to record the annual collection of the rental.
c. Prepare table of amortization
d. Prepare journal entry to record the recognition of interest income for the year 2020 &
2021.
Answer:
Gross rental or lease receivable (500,000 x 4
years)
PV of gross rentals
Unearned interest income
2,000,000
Lease receivable
Machinery
Unearned interest income
2,000,000
1,518,650
481,350
Cash
500,000
1,518,650
481,350
Lease receivable
500,000
2020
Unearned interest income
Interest income
182,238
2021
Unearned interest income
Interest income
144,107
182,238
144,107
16. Direct financing lease – with initial direct cost
16
Assuming the same details as above exempt that, on January 1, 2020, Lessor Company paid
initial direct cost of P66,300.
a. Compute for the new interest rate.
b. Prepare journal entry to record payment of initial direct cost, lease receivables and annual
collection of rental.
c. Prepare the table of amortization.
d. Prepare journal entry to record the recognition of interest income for the year 2020 &
2021.
Answer:
Cost of machinery
Initial direct cost
Net investment income
1,518,650
66,300
1,584,950
Gross rental or lease receivable (500,000 x 4
years)
PV of gross rentals
Unearned interest income
2,000,000
1,584,950
415,050
Trial and error = new implicit rate is 10%
500,000 x 3.1699 = 1,584,950
Machinery (initial indirect cost)
Cash
66,300
Lease receivable
Machinery
Unearned interest income
2,000,000
1,584,950
415,050
Cash
500,000
66,300
Lease receivable
500,000
2020
Unearned interest income
Interest income
158,495
2021
Unearned interest income
Interest income
124,344
158,495
124,344
17. Direct financing lease – with residual value
On January 1, 2020, Lessor Company leased a machinery to another entity with the following
details:
Cost of machinery
3,194,410
Residual value
500,000
17
Useful life and lease term
4 years
Implicit interest rate
10%
PV of 1 at 10% for 4 periods
0.6830
PV of an ordinary annuity of 1 at 10% for 4 periods
3.1699
a. Compute for the net investment to be recovered from rental and annual rental.
b. Compute for the gross investment and unearned interest income.
c. Prepare table of amortization
d. Prepare journal entry to record (a) direct financing lease; (b) collection of annual
rental; (c) interest income (d) machinery revert to the lessor on Dec 31, 2023.
e. Assuming the fair value of the machinery is 400,000 which is lower than the residual
value of P500,000 (a) under the guaranteed scenario, prepare the journal entry (b)
under the unguaranteed scenario, prepare also the journal entry.
Answer:
Cost of machinery
PV of residual value (500,000 x 0.683)
Net investment to be recovered from rental
Divided by PV of OA
Annual rental
3,194,410
(341,500)
2,852,910
3.1699
900,000
Gross rentals (9--,000 x 4)
Residual value (whether guaranteed or
unguaranteed)
Gross investment
Cost of machinery – net investment
Unearned interest income
3,600,000
500,000
Lease receivable
Machinery
Unearned interest income
4,100,000
3,194,410
905,590
Cash
900,000
4,100,000
(3,194,410)
905,590
Lease receivable
900,000
Unearned interest income
Interest income
319,441
Machinery
Lease receivable
500,000
319,441
500,000
Guaranteed scenario
Cash
Machinery
Lease receivable
100,000
400,000
500,000
Unguaranteed scenario
18
Loss on finance lease
Machinery
Lease receivable
100,000
400,000
500,000
18. Direct financing lease – transfer of title to lessee
On January 1, 2020, Lessor Company leased a machinery to another entity with the following
details:
Cost of machinery
3,449,600
Residual value
500,000
Useful life and lease term
5 years
Implicit interest rate
8%
PV of an ordinary annuity of 1 in advance at 8% for 5 periods
4.312
The annual rental is payable in advance on January 1 of each year starting January 1, 2020. The
lease provides for a transfer of title to the lessee at the end of the lease term.
a. Compute for the annual rental and the unearned interest income.
b. Prepare table of amortization
c. Prepare journal entry to record the (a) lease receivables (b) rental payment (c) interest
income for year 2020 and 2021.
Answer:
Cost of machinery
Divided by PV of OA
Annual rental
3,449,600
4.312
800,000
Gross rentals (9--,000 x 4)
Cost of machinery – net investment
Unearned interest income
4,000,000
(3,449,600)
550,400
2020
Lease receivable
Machinery
Unearned interest income
Cash
4,000,000
3,449,600
550,400
800,000
Lease receivable
Unearned interest income
Interest income
800,000
211,968
211,968
2021
Cash
800,000
19
Lease receivable
Unearned interest income
Interest income
800,000
164,925
164,925
19. (Sales type lease) Lessor Company is a dealer in machinery. On January 1, 2020, a machinery
was leased to Lessee Company with the following provisions:
Annual rental payable at the end of each year
400,000
Lease term
5 years
Useful life of machinery
5 years
Cost of machinery
1,000,000
Implicit interest rate
12%
PV of annuity of 1 for 5 years at 12%
3.60
a. Compute for the unearned interest income and gross profit on sale.
b. Prepare journal entry to record (a) sale; (b) cost of goods sold; (c) collection of the
annual rental; (d) interest income for 2020.
Answer:
Gross rentals (400,000 x 5)
PV of rentals (400,000 x 3.6)
Unearned interest income
2,000,000
1,440,000
560,000
PV of rentals – sales
Cost of machinery – cost of goods sold
Gross profit on sale
1,440,000
1,000,000
440,000
Lease receivable
Sales
Unearned interest income
2,000,000
1,440,000
560,000
Cost of goods sold
Inventory
1,000,000
1,000,000
Cash
400,000
Lease receivable
Unearned interest income
Interest income
400,000
172,800
172,800
20. (Sales type lease with residual value) Lessor Company is a dealer in machinery. On January 1,
2020, a machinery was leased to Lessee Company 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 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, 2024, the machinery will revert to Lessor
Company. The perpetual inventory system is used.
a. Compute for the unearned interest income and gross income.
b. Prepare journal entry to record the sale and the payment for initial direct cost.
c. Assume the residual value is unguaranteed, compute for the unearned interest income
and gross income.
20
d. Prepare table of amortization.
e. Prepare journal entry to record the revert to the Lessor Company on the termination
date on December 31, 2024.
Answer:
Gross rentals (800,000 x 5)
Residual value guarantee
Lease receivable – gross investment
4,000,000
200,000
4,200,000
PV of gross rentals (800,000 x 3.7908)
PV of residual value guarantee (200,000 x 0.6209)
Total PV – net investment
3,032,640
124,180
3,156,820
Lease receivable
Total PV
Unearned interest income
4,200,000
(3,156,820)
1,043,180
Sales equal to total PV
Cost of machinery – cost of goods sold
Initial direct cost
Gross income
3,156,820
(2,000,000)
(100,000)
1,056,820
Lease receivable
Cost of goods sold
Sales
Unearned interest income
Inventory
4,200,000
2,000,000
3,156,820
1,043,180
2,000,000
Cost of goods sold
Cash
100,000
100,000
Unguaranteed residual value
Gross rentals (800,000 x 5)
Residual value guarantee
Lease receivable – gross investment
4,000,000
200,000
4,200,000
PV of gross rentals (800,000 x 3.7908)
PV of residual value guarantee (200,000 x 0.6209)
Total PV – net investment
3,032,640
124,180
3,156,820
Lease receivable
Total PV
Unearned interest income
4,200,000
(3,156,820)
1,043,180
Sales equal to total PV
Cost of machinery – cost of goods sold
Initial direct cost
Gross income
3,156,820
(2,000,000)
(100,000)
1,056,820
Same with guarantee residual value
Lease receivable
Cost of goods sold
Sales
Unearned interest income
4,200,000
2,000,000
3,156,820
1,043,180
21
Inventory
2,000,000
Cost of goods sold
Cash
100,000
Cash
800,000
100,000
Lease receivable
Unearned interest income
Interest income
800,000
315,682
315,682
Return of asset to the lessor
Guarantee or unguaranteed
Inventory (machinery)
Lease receivable
200,000
Cash
Inventory
Lease receivable
50,000
150,000
200,000
200,000
21. (Sales type lease with purchase option) An entity is a dealer in equipment. On January 1, 2020,
an equipment is leased to another entity with the following provisions:
Annual rental payable at the end of each year
500,000
Lease term
4 years
Useful life of equipment
5 years
Cost of equipment
1,000,000
Initial direct cost paid by lessor
100,000
Purchase option
200,000
Implicit interest rate
8%
PV of an ordinary annuity of 1 at 8% for 4 periods
3.312
PV of 1 at 8% for 4 periods
0.735
It is reasonably certain that the lessee will exercise the purchase option on December 31, 2023.
a. Compute for the unearned interest income and gross income.
b. Prepare journal entry to record the sale.
c. Prepare table of amortization and the necessary journal entries.
d. Prepare journal entry to record the exercise of purchase option by the lessee on
December 31, 2023.
Answer
Gross rentals (500,000 x 5)
Residual value guarantee
Lease receivable – gross investment
2,000,000
200,000
2,200,000
22
PV of gross rentals (500,000 x 3.312)
PV of residual value guarantee (200,000 x 0.735)
Total PV – net investment
1,656,000
147,000
1,803,000
Gross investment
Net investment
Unearned interest income
2,200,000
(1,803,000)
397,000
Sales equal to total PV
Cost of machinery – cost of goods sold
Gross income
1,803,000
1,100,000
703,000
Cost of equipment
Initial direct cost
Cost of goods sold
1,000,000
100,000
1,100,000
Lease receivable
Cost of goods sold
Sales
Unearned interest income
Inventory
Cash
2,200,000
1,100,000
1,803,000
397,000
1,000,000
100,000
Cash
800,000
Lease receivable
Unearned interest income
Interest income
800,000
144,240
144,240
Exercise of purchase option
Cash
200,000
Lease receivable
200,000
22. (Actual sale of underlying asset) An entity actually sold an equipment that it had been leasing
under a sales type lease 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
5,000,000
Unearned interest income
1,200,000
Compute for the loss on sale of leased equipment and prepare journal entry.
Answer:
Sales price
Carrying amount of lease receivable:
Lease receivable
Unearned interest income
Loss on sale of leased equipment
3,500,000
5,000,000
(1,200,000)
3,800,000
(300,000)
Journal entry to record the actual sale
23
Cash
Unearned interest income
Loss on sale of leased equipment
Lease receivable
3,500,000
1,200,000
300,000
5,000,000
23. (Sales and leaseback – sale price at fair value) 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 amount of P1,800,000, net of
accumulated depreciation of P1,200,000.
a. Prepare journal entry using the books of seller-lessee to record the sale and annual rental.
b. Prepare journal entry using the books of buyer-lessor to record the purchase, annual
rental and depreciation of the machinery.
Answer
Books of seller-lessee
Cash
Acc Dep
Machinery
Gain on right transferred
To record sale
2,000,000
1,200,000
3,000,000
200,000
Rent expense
Cash
300,000
300,000
To record annual rent
Books of buyer-lessor
Machinery
Cash
2,000,000
2,000,000
To record purchase
Cash
100,000
Rent income
To record annual rent
Depn
100,000
200,000
Acc Depn
2,000,000/10
200,000
24. (Sale price at fair value) On January 1, 2020, an entity sold an equipment with remaining life of
10 years and immediately leased it back for 4 years at the prevailing market rental.
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%
PV of an ordinary annuity of 1 at 10% for four periods
3.170
a. Compute for the lease liability and prepare table of amortization
b. Compute for the cost of right of use asset.
c. Compute for the total gain to be recognized.
d. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of the right of
use asset.
e. In the books of buyer-lessor, prepare journal entry to record the (a) purchase of the
underlying asset; (b) annual rental; (c) annual depreciation of equipment.
Answer
24
PV of rentals (800,000 x 3.17) = 2,536,000
Cost of right of use asset (2,536,000 / 6M x 4.5M) = 1,902,000
Total Gain (6M – 4.5M = 1.5M)
Books of seller-lessee
Cash
Right of use asset
Equipment
Lease liability
Gain on right transferred
6,000,000
1,902,000
4,500,000
2,536,000
866,000
Interest expense (10% x 2,536,000)
Lease liability
Cash
253,600
546,400
Depn (1,902,000 / 4)
Acc Depn
475,500
800,000
475,500
Books of buyer-lessor
Equipment
Cash
6,000,000
6,000,000
To record purchase
Cash
800,000
Rent income
To record annual rent
Depn
800,000
600,000
Acc Depn
6,000,000/10
600,000
25. (Sales price above fair value) On January 1, 2020, an entity sold a building with remaining life
of 20 years and immediately leased it back for 5 years.
Sale price
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%
PV of an ordinary annuity of 1 at 12% for five periods
3.60
a. Compute for the (a) lease liability; (b) excess sales price over fair value; (c) cost of
right of use asset; (d) right transferred to buyer-lessor; (e) adjusted total gain.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
building; (b) annual rental lease; (c) annual rental related to financing; (d)
depreciation of the building.
d. Prepare amortization related to financial asset.
Answer
Lease liability (1,500,000 x 3.60) = 5,400,000
PV of lease liability related to rental (5.4M – (20M – 18M)) = 3.4M
25
Cost of right of use asset (3.4M / 18M x 10.80M) = 2,040,000
Adjusted total gain (18M – 10.80M) = 7.2M
Books of seller-lessee
Cash
Right of use asset
Building
Lease liability
Gain on right transferred (squeeze)
20,000,000
2,040,000
10,800,000
5,400,000
5,840,000
Interest expense (10% x 5,400,000)
Lease liability
Cash
648,000
852,000
Depn (2,040,000 / 5)
Acc Depn
408,000
1,500,000
408,000
Books of buyer-lessor
Building
Financial assets
Cash
18,000,000
2,000,000
20,000,000
To record purchase
Cash
944,444
Rent income
To record annual rent
Cash
944,444
555,556
Financial asset
Interest income
315,556
240,000
Depn
900,000
Acc Depn
18,000,000/20
900,000
Allocation of the annual rent
Rental income
Financial asset
Total PV
Present value
3,400,000
2,000,000
5,400,000
Fraction
3,400/5,400
2,000/5,400
Allocation
944,444
555,556
1,500,000
26
26. (Sale price below fair value) On January 1, 2020, an entity sold an equipment with remaining
life of 8 years and leased it back for 5 years.
Sale price
5,000,000
Fair value of building
6,000,000
Carrying amount of building
4,800,000
Annual rental payable at the end of each year
900,000
Implicit interest rate
8%
PV of an ordinary annuity of 1 at 8% for five periods
3.99
a. Compute for the (a) lease liability; (b) cost of right of use asset; (c) gain to be
recognized; (d) gain not to be recognized; (e) total gain.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
equipment; (b) annual rental; (c) depreciation of the equipment.
d. Prepare amortization table.
Answer
PV rentals (900,000 x 3.99) = 3,591,000
Total lease liability (3,591,000 + (6M – 5M)) = 4,591,000
Cost of right of use asset (4,591,000 / 6M x 4.8M) = 3,672,800
Total gain (6M – 4.8M) = 1.2M
Books of seller-lessee
Cash
Right of use asset
Equipment
Lease liability
Gain on right transferred (squeeze)
5,000,000
3,672,800
4,800,000
3,591,000
281,800
Interest expense (8% x 3,591,000)
Lease liability
Cash
287,280
612,720
Depn (3,672,800 / 5)
Acc Depn
734,56
900,000
734,560
Books of buyer-lessor
Equipment
Cash
5,000,000
5,000,000
To record purchase
Cash
900,000
Rent income
To record annual rent
Depn
900,000
625,000
Acc Depn
5,000,000/8
625,000
27. (Sale price at fair value with loss) On January 1, 2020, an entity sold a building with remaining
life of 25 years and immediately leased it back for 3 years.
27
Sale price at fair value
Carrying amount
Annual rental payable at the end of each year
Implicit interest rate
PV of an ordinary annuity of 1 at 8% for three periods
10,000,000
12,000,000
500,000
8%
2.58
a. Compute for the (a) lease liability; (b) cost of right of use asset; (c) right transferred
to buyer-lessor; (d) loss to be recognized; (d) loss not to be recognized; (e) total loss.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
building; (b) annual rental; (c) depreciation of the building.
d. Prepare amortization table.
Answer:
PV of rentals (500,000 x 2.58) = 1,290,000
Cost of right of use asset (1,290,000 x 10M / 12M) = 1,548,000
Total loss (10M – 12M) = 2M
Books of seller-lessee
Cash
Right of use asset
Loss on right transferred
Building
Lease liability
10,000,000
1,548,000
1,742,000
12,000,000
1,290,000
Interest expense (8% x 1,290,000)
Lease liability
Cash
103,200
396,800
Depn (1,548,000 / 3)
Acc Depn
516,000
500,000
516,000
Books of buyer-lessor
Building
Cash
10,000,000
10,000,000
To record purchase
Cash
500,000
Rent income
To record annual rent
Depn
500,000
400,000
Acc Depn
10,000,000/25
400,000
28