MODULE 19
LEASES
LEARNING OBJECTIVES:
1. Identify a lease.
2. Describe the general recognition and recognition exemption relating to the accounting
for lease by the lessee.
3. State the lease classification by a lessor.
4. State the indicators of a finance lease.
5. Describe the accounting for finance leases and operating leases by a lessor
OVERVIEW
PFRS 16 specifies how an PFRS reporter will recognise, measure, present and disclose leases.
The standard provides a single lessee accounting model, requiring lessees to recognise assets
and liabilities for all leases unless the lease term is 12 months or less or the underlying asset
has a low value. Lessors continue to classify leases as operating or finance, with PFRS 16’s
approach to lessor accounting substantially unchanged from its predecessor, PAS 17.
PFRS 16 was issued in January 2016 and applies to annual reporting periods beginning on or
after 1 January 2019.
Acquiring new knowledge
Asynchronous - links to more information: www.farhatlectures.com; http://www.ifrsbox.com
A synchronous discussion for this lesson will be scheduled on November 3, 2020 (Tuesday 7:30
– 8:30 AM)
Objective
PFRS 16 establishes principles for the recognition, measurement, presentation and disclosure
of leases, with the objective of ensuring that lessees and lessors provide relevant information
that faithfully represents those transactions.
Scope
PFRS 16 Leases applies to all leases, including subleases, except for:
o leases to explore for or use minerals, oil, natural gas and similar non-regenerative
resources;
o leases of biological assets held by a lessee (see PAS 41 Agriculture);
o service concession arrangements (see Service Concession Arrangements);
o licences of intellectual property granted by a lessor (see PFRS 15 Revenue from
Contracts with Customers); and
o rights held by a lessee under licensing agreements for items such as films, videos,
plays, manuscripts, patents and copyrights within the scope of PAS 38 Intangible Assets
A lessee can elect to apply PFRS 16 to leases of intangible assets, other than those items listed
above.
Lease – is “ a contract, that conveys the right to use an asset for a period of time in exchange
for consideration.” (PFRS 16. Appendix A)
Parties to a lease contract:
1. Lessee – the “entity that obtains the right to use an underlying asset for a period of time
in exchange for consideration,.”
2. Lessor - the “entity that provides the right to use an underlying asset for a period of
time in exchange for consideration.” (PFRS 16. Appendix A)
Identifying a lease
A contract is, or contains, a lease if it conveys the right to control the use of an identified asset
for a period of time in exchange for consideration. (PFRS 16.9)
Control is conveyed where the customer has both the right to direct the identified asset’s use
and to obtain substantially all the economic benefits from that use.
Identified asset
An asset can be identified by being explicitly stated in the contract or by being implicitly
specified at the time the asset is made available for use by the customer.
Illustration:
Customer A enters into a five-year contract with Supplier B for the use of delivery truck. The
specification of the truck is stated in the contract (brand, engine, capacity, dimension, etc.)
Case 1: The truck is readily available at the inception of the contract.
Analysis: The delivery truck is identified asset, it is identified by being explicitly specified in the
contract.
Case 2: The truck is not yet built at the inception of the contract
Analysis: The truck is an identified asset, although, the truck cannot be identified at the
inception of the contract, it is expected to be identifiable at the commencement of the lese, i.e.,
it is implicitly specified at the time that the asset is made available for use by the customer.
Portion of assets
A portion of an asset is an identified asset if it is physically distinct ( e.g.’ a floor of a building). If
not physically distinct, the portion is not identified asset, unless it represents substantially all of
all of the capacity of the asset thereby providing the customer the right to obtain substantially all
of the economic benefits from the asset.
Right to obtain economic benefits from use
A customer controls the use of an identified asset if it has the right to obtain substantially all of
the economic benefit from the asset throughout the period of use.
Right to direct the use
A customer has the right to direct the use of an identified asset throughout the period of use if:
a. The customer has the right to direct how and for what purpose the asset is used
throughout the period of use; or
b. The asset’s use is predetermined and the supplier is precluded from changing the
predetermined use.
Protective right
Protective rights include contractual restrictions designed to protect the supplier’s interest in the
asset or its personnel, or to ensure compliance with laws and regulation.
Accounting by lessees (Initial measurement)
Upon lease commencement a lessee recognises a right-of-use asset and a lease liability.
The right-of-use asset is initially measured at the amount of the lease liability plus any
initial direct costs incurred by the lessee. Adjustments may also be required for lease incentives, payments at or prior to commencement and restoration obligations or similar.
Subsequent measurement
After lease commencement, a lessee shall measure the right-of-use asset using a cost model,
unless:
i)
the right-of-use asset is an investment property and the lessee fair values its investment
property under PAS 40; or
ii)
the right-of-use asset relates to a class of PPE to which the lessee applies PAS 16’s
revaluation model, in which case all right-of-use assets relating to that class of PPE can
be revalued.
Under the cost model a right-of-use asset is measured at cost less accumulated depreciation
and accumulated impairment.
The lease liability is initially measured at the present value of the lease payments payable
over the lease term, discounted at the rate implicit in the lease if that can be readily determined.
If that rate cannot be readily determined, the lessee shall use their incremental borrowing rate.
Variable lease payments that depend on an index or a rate are included in the initial measurement of the lease liability and are initially measured using the index or rate as at the commencement date. Amounts expected to be payable by the lessee under residual value guarantees are
also included.
Variable lease payments that are not included in the measurement of the lease liability are
recognised in profit or loss in the period in which the event or condition that triggers payment
occurs, unless the costs are included in the carrying amount of another asset under another
Standard.
The lease liability is subsequently remeasured to reflect changes in:
o the lease term (using a revised discount rate);
o the assessment of a purchase option (using a revised discount rate);
o the amounts expected to be payable under residual value guarantees (using an
unchanged discount rate); or
o future lease payments resulting from a change in an index or a rate used to determine
those payments (using an unchanged discount rate).
The remeasurement are treated as adjustments to the right-of-use asset.
Lease modifications may also prompt remeasurement of the lease liability unless they are to be
treated as separate leases.
Illustration:
On January 1, 20x1, Entity B enters into a 3-year lease of equipment for an annual rent of
100,000 payable at the end of each year. The equipment has a remaining useful life of 10
years. The interest rate implicit in the lease is 10%, while the lessee’s incremental borrowing
rate is 12%. Entity B uses the straight-line method of depreciation. The relevant present value
factors are as follows:
PV of an ordinary annuity of 1 @ 10%,n3 2.48685
PV of an ordinary annuity of 1 @ 12%, 3
2.40183
Initial & subsequent measurement of lease liability
Fixed payment
100,000
Multiply by: PV of an ordinary annuity of 1 at 10% x 2.48685
Initial lease liability
1/1/20x1
248,685
Payment 12/31
100,000
Interest (10% x 248,685)
(24,869)
(75,131)
Lease liability 12/31/20x1
173,554
Initial & subsequent measurement of Right-of-use asset
Right-of-use asset1/1 (initial lease liability + IDC) 248,685
Depreciation (248,685/3)
(82,895)
Carrying amount 12/31/20x1
165,790
Recognition exemptions
Instead of applying the recognition requirements of PFRS 16 described below, a lessee may
elect to account for lease payments as an expense on a straight-line basis over the lease term
or another systematic basis for the following two types of leases:
i)
leases with a lease term of 12 months or less and containing no purchase options – this
election is made by class of underlying asset; and
ii)
leases where the underlying asset has a low value when new (such as personal
computers or small items of office furniture) – this election can be made on a lease-bylease basis.
Illustration: Recognition exemption
Assuming the recognition exemptions are applied to the previous illustration. Entity B does not
recognized any lease liability or right-of-use asset, instead, the payment of 100,000 every year
shall be recognized as expense.
Separating the component of a contract
An entity accounts for each lease component of a contract separately from the non-lease
components of that contract.
A lessee allocates the consideration in the contract to each lease component on the basis of the
relative stand-alone price of the lease component and the aggregate stand-alone price of the
non-lease component.
Illustration:
ABC Co. enters into a 3-year contract for three machines – a printer, binder, and electric power
converter equipment. The binding machine can be use on its own. However, the converter is
necessary to run the printer. ABC would not lease a printer without a converter, and vice versa.
The contract requires fixed annual payments of 240,000, itemized as follows: 225,000 rent for
the 3 machines, 11,000 for maintenance, and 4,000 for administrative task.
Analysis:
The contract includes two lease components and three non-lease components:
❖ Lease components: (1) lease of binder and (2) lease of printer and converter
❖ Non-lease components: three maintenance services for the 3 machines
The rights to use the printer and the converter are treated as one component because:
a. The lessee cannot benefit from the use of either asset on its own or together with other
resources that are readily available to the lessee; and
b. The printer and converter are highly dependent on each other.
The payment for administrative task is not separate component because it does not transfer
goods or services to the lessee. This is included in the total consideration that is allocated to
the separately identified components.
ABC Co. identifies the following stand-alone prices:
Binder
52,000
Printer
180,000
Maintenance of binder
4,000
Maintenance of printer
8,000
Maintenance of converter
1,000
The total consideration of 240,000 is allocated to the separately identified components as
follows:
Stand-alone prices
Allocation
Binder
52,000
240K x 52/260 = 48,000
Printer & converter
(180,000+ 15,000) 195,000
240K x 95/260 = 180,000
Maintenance
(4K+8K+1K)
13,000
240K x 13/260 = 12,000
Totals
260,000
240,000
Accounting:
The lessee shall:
a. Recognize a lease liability and a right of use asset for the binder equal to the present
value of 48,000;
b. Recognize a lease liability and a right-of-use asset for the printer and converter equal to
the present value of 180,000; and
c. Recognize the 12,000 allocated to non-lease components as maintenance expense at
the end of each year over the lease term.
Practical expedient
PFRS 16 allows an entity to elect, by class of underlying asset, not to separate the lease and
non-lease components of a contract and instead account for them as single lease component.
Applying the practical expedient simplifies accounting but it would increase the amounts
recognized for the lease liability and right-of-use asset and this could have implications for
impairment.
Presentation – Statement of financial position
Right-of-use assets are presented either:
a. Separate from other assets; or
b. Together with other assets as if they were owned, with disclosure of the line items that
include the right-of-use assets
Right-of-use assets that meet the definition of investment property are presented as investment
property
Lease liabilities are presented either:
a. Separately from other liabilities; or
b. Together with other liabilities, with disclosure of the line items that include the lease
liabilities.
Statement of comprehensive income
Depreciation and interest expense are presented separately
Accounting by lessors
Lessors shall classify each lease as an operating lease or a finance lease.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership of an underlying asset. Otherwise a lease is classified as an operating
lease.
Examples of situations that individually or in combination would normally lead to a lease being
classified as a finance lease are:
o the lease transfers ownership of the asset to the lessee by the end of the lease term
o the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the
inception of the lease, it is reasonably certain that the option will be exercised
o the lease term is for the major part of the economic life of the asset, even if title is not
transferred
o at the inception of the lease, the present value of the minimum lease payments amounts
to at least substantially all of the fair value of the leased asset
o the leased assets are of a specialised nature such that only the lessee can use them
without major modifications being made
Operating lease – is a lease that does not transfer substantially all the risk and rewards
incidental to ownership of an underlying asset.
Inception and Commencement of lease
Lease classification is made at the inception date and is reassessed only if there is a lease
modification. Changes in estimates, or changes in circumstances, do not give rise to a new
classification of a lease for accounting purposes.
Inception date – is the earlier of (a) the date of the lease agreement, and (b) the
date and (b) the date of commitment by the parties to the
principal provisions of the lease.
As at this date:
a. A lease is classified as either an operating or a finance lease; and
b. In the case of a finance lease, the amounts to be recognized at the commencement date
are determined.
Commencement date –is the date on which a lessor makes an underlying asset
available for use by a lessee. It is on this date that the lessee is entitled to exercise its right to
use the leased asset.
Finance lease - Initial measurement
A lessor recognizes an asset from finance lease as receivable measured at an amount equal to
the net investment in the lease.
Gross investment in the lease (gross lease receivable) – “the sum of:
a. The lease payments receivable by the lessor under a finance lease; and
b. Any unguaranteed residual value accruing to the lessor.”
Net investment in the lease (net lease receivable) – “the gross investment in the
lease discounted at the interest rate implicit in the lease.”
Unearned finance income (unearned interest) – “the difference between:
a. The gross investment in the lease; and
b. the net investment in the lease.” (PFRS 16. Appendix A)
Lease payments include the following:
a. Fixed payments, including in-substance fixed payments, less any lease incentives
payable;
b. Variable lease payment that depend on an index or a rate, initially measured using the
index or rate as at the commencement date;
c. Guaranteed residual value.
d. The exercise price of a purchase option if the lessee is reasonable certain to exercise
that option; and
e. Payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease. (PFRS 16.70)
Discount rate
The net investment is measured using the interest rate implicit in the lease.
Subsequent measurement
The net investment in the lease is subsequently measured similar to an amortized cost
financial asset,
Accordingly:
➢ Finance income is computed using the effective interest method and recognized in the
profit or loss.
➢ Lease payments are applied against the gross investment in the lease to reduce both
the principal and unearned finance income.
Illustration: Finance lease
On January 1, 20x1, Entity C Leases out an equipment to entity X.
Information on the lease is as follows:
Lease term
3 years
Annual rent payable at the end of each year 100,000
Rate implicit in the lease
10%
The lease provides for the transfer of ownership of the equipment to the lessee at the end of the
lease term.
The relevant present value factors is as follows:
PV of and ordinary annuity of 1 at 10%; n=3 2.48685
Analysis:
The lease is a finance lease because it transfers ownership of the asset to the lessee by the
end of the lease term.
Initial measurement:
Gross investment = Lease payments + unguaranteed residual value
Fixed lease payments (100,000 x 3)
300,000
Add: Unguaranteed residual value
Gross investment
300,000
Net investment = Present value of gross investment (PV of lease payment + PV of
unguaranteed residual value)
Fixed lease payments
100,000
Multiply by: PV of an ordinary annuity of 1 at 10%; n=3
2.48685
Net investment in the lease
248,685
Unearned interest income = Gross investment – Net investment
Gross investment
300,000
Less: Net investment
(248,685)
Unearned interest income
51,315
Interest Income = Net investment x Rate implicit to the lease
Net investment
248,685
Multiply by: Rate implicit to the lease
x 10%
Interest income
24,869
Subsequent measurement
The net investment in the lease is subsequently measured at amortized cost.
Operating Lease
An operating lease is a lease that does not transfer substantially all the risk and rewards
incidental to ownership of an underlying asset.
The accounting for operating lease is straight-forward. The lessor recognizes the lease
payments as income on a straight line basis over the lease term, unless another systematic
basis is more representative of the pattern in which benefit from the use of underlying asset is
diminished.
The accounting for operating leases by a lessor is the same as the recognition exemption
available to lessee for “short-term” and “low value” leases.
Illustration: Operating lease
Assume the lease in the illustration for Entity B is an operating lease. Entity Y recognizes the
100,000 annual lease payments as income in the periods in which they are earned.
Lease of land and building
When lease includes both land and buildings elements, a lessor assesses the classification of
each element as a finance lease or operating lease separately.
In determining whether the land element is an operating or finance lease, an important
consideration is that land normally has indefinite life, and therefore the “useful life or 75%
criterion does not apply.
However, even if the lease does not transfer title over the land, a lessor may nonetheless
classify the land as finance lease it the lease extends to a relatively very long period of time.
To account for the land and building components of a lease separately, a lessor allocates the
lease payments to the elements based on their relative fair values at the inception date.
If no reliable allocation basis exist, the entire lease is classified as finance lease, unless it is
clear that both elements are operating leases, in which case the entire lease is classified as
operating lease.
Subleases
Sublease is “a transaction for which an underlying asset is re-leased by a lessee (intermediate
lessor) to a third party, and the lease (head lease) between the head lessor and lessee remains
in effect.” (PFRS 16. Appendix A)
An intermediate lessor classifies a sublease as a finance lease or an operating lease as follows:
a. If the head lease is a short-term lease that the entity, as a lessee, has accounted for
applying the recognition exemption, the sublease is classified as an operating lease.
b. Otherwise, the sublease is classified by reference to the right-of-use asset arising from
the head lease, rather than by reference to the underlying asset.
Sale and leaseback transactions
To determine whether the transfer of an asset is accounted for as a sale an entity applies the
requirements of PFRS 15 for determining when a performance obligation is satisfied.
If an asset transfer satisfies PFRS 15’s requirements to be accounted for as a sale the seller
measures the right-of-use asset at the proportion of the previous carrying amount that relates to
the right of use retained.
Accordingly, the seller only recognises the amount of gain or loss that relates to the rights transferred to the buyer.
If the fair value of the sale consideration does not equal the asset’s fair value, or if the lease
payments are not market rates, the sales proceeds are adjusted to fair value, either by
accounting for prepayments or additional financing.
Transfer of asset is a sale
If the transfer qualifies as a sale under PFRS 15:
a. The seller/lessee shall:
i. Measure the right-of-use asset arising from leaseback at the proportion of the
previous carrying amount of the asset that relates to the right of use retained by
the seller-lessee; and
ii. Recognize only the amount of any gain or loss that relates to the
rights transferred to the buyer-lessor.
b. The buyer-lessor shall account for the purchase of the asset applying applicable
standards (e.g., PAS 16 if the asset is an item of PPE), and for the lease applying the
lessor accounting under PFRS 16.
Adjustments
If (a) the sales price is not equal to the fair value of the asset, or if (b) the lease payments are
not at market rates, the following adjustments shall be made to measure the sales proceeds at
fair value:
1. Any below-market terms shall be accounted for as prepayment of lease payments; and
2. Any above-market terms shall be accounted for as additional financing provided by the
buyer-lessor to the seller-lessee.
The adjustment is measured based on the more readily determinable of:
a. The difference between the fair value of the consideration for the sale and fair value of
the asset; and
b. The difference between the present value of the contractual payments for the lease at
market rates.
Transfer of the asset is not a sale
If the transfer does not qualify as a sale, the parties shall account for it as a financing
transaction. Accordingly,
a. The seller-lessee continues to recognize the asset and accounts for the amounts
received as financial liability under PFRS 9.
b. The buyer-lessor does not recognize the transferred asset and accounts for the amounts
paid as financial asset under PFRS 9.
Summary:
Identifying a lease
Essential elements
Guidance
1. Identified asset
- Identified explicitly and implicitly.
- Not identified if the supplier has substantive
substitution right.
- A portion of an asset that is: (a) physically distinct
can be an identified asset; (b)not physically distinct
is not an identified asset.
2. Rights to obtain
-Consider direct and indirect benefits
Substantially all of
-Consider only the economic benefits within the defined scope
the economic
of a customer’s rights to use an asset, and not beyond.
Benefits
3. Right to direct the use
-Customer has the right to decide how and for what purpose the
the asset is used.
Lessees accounting
➢ General Recognition. A Lessee recognizes both a right-of-use asset and a lease liability.
➢ The Lease liability is initially measured at the present value of the lease payments that
are not yet paid at the commencement date and subsequently measured at the
amortised cost.
➢ The discount used is the interest rate implicit in the lease. If this is not determinable, the
lessee’s incremental borrowing rate is used.
➢ The right-to-use asset is initially measured at cost and subsequently measured similar to
purchased asset (i.e., cost model , revaluation model or fair value model, as appropriate)
➢ Recognition exemption: For “short term” and “low value” leases, the lessee may elect
recognized lease payments as expense over the lease term using the straight-line basis,
or another more appropriate basis.
Lessor Accounting
➢ A Lessor classifies a lease as either a finance lease or an operating lease. A finance
lease transfers substantially all the risks and rewards incidental to ownership of an
underlying asset; an operating lease does not.
➢ Indicator of a finance lease: (1) Transfer of ownership; (2) Bargain purchase option
‘BPO’; (3) Major part of useful life 75%; (4) PV of LP is substantially all of fair value
‘90%’; (5) Specialized in nature.
➢ Finance lease: Initial accounting: Lessor derecognizes leased asset (and hence,
depreciating it) and recognizes net investment in the lease. Subsequent accounting: net
investment in the lease is subsequently measured at amortized cost.
➢ Net investment = PV of lease payments + PV of Unguaranteed residual value.
➢ Operating lease: Lessor recognizes lease payments as lease income over the lease
term using the straight line basis, or another more appropriate basis. Lessor continues to
depreciate the leased asset.
MODULE # 19 Post-test
PRACTICAL ACCOUNTING 1 – REVIEW
LEASES
PROF. U.C. VALLADOLID
Multiple Choice
Identify the choice that best completes the statement or answers the question.
All answers shall be submitted on or before November 6, 2020 (Friday)
1. On January 1, 2021 Corpus Company leased a building to Brill under an operating lease for ten years at 600,000 per
year, payable at the first day of each lease year.
Corpus has paid an amount of 250,000 for a real estate broker as a finder’s fee.
The building is depreciated annually for 120,000 aside from this the company has also paid insurance and property
tax expense of P90,000.
What should be the reported net income for 2021?
a. 365,000
b. 140,000
c. 600,000
d. 455,000
2. Mark Company leased a new machine to Co Company on January 1, 2020. The lease expires on January 1, 2025 with
an annual rental of 750,000. Co Company paid 350,000 to Mark as a lease bonus and 175,000 as a security deposit
to be refunded upon the expiration of the lease. What amount of rental revenue should be reported for 2020?
a. 800,000
b. 810,000
c. 820,000
d. 830,000
3. On January 1, 2021, Cignal Company leased a warehouse to Sael Corporation under an operating leased for ten
years at 80, 000 per year payable on the first day of each leased year. Cignal Company agrees to pay the lessee’s
relocation or moving cost as an incentive to Sael Corporation for entering into the new lease. The moving cost is
6,000. What amount of rent income should Cignal Company recognized in its 2021 profit or loss?
a. 79,000
b. 79,500
c. 79,400
d. 80,200
4. On January 1, 2022, WAO Company leased a building to OOF Company for a ten year term at an annual rental of
500,000. At inception of the lease, WAO received 2,000,000 covering the first two years’ rent of 1,000,000 and a
security deposit of 1,000,000.
This deposit will not be returned to OOF upon expiration of the lease but will be applied to payment of rent for the last
two years of the lease.
What portion of the 2,000,000 should be reported as current liability on December 31, 2022?
a. 1,500,000
b. 1,000,000
c. 500,000
d. 0
5. On January 1, 2020, Monggu Corp leased a delivery van to Vivi Company under a 4-year operating lease. Total rent
for the term of the lease will be 360,000 payable as follows:
1st 12 months at Php 3,000 / month
36,000
2nd 12 months at Php 6,000 / month
3rd 12 months at Php 9,000 / month
4th 12 months at Php 12,000 / month
What amount should be reported as rent revenue for the year ended on December 31, 2020?
a. 36,000
b. 90,000
c. 120,000
d. 360,000
6. On January 1, 2020, ASIO Company leased a building from a lessor with the following information:
Annual rental payable at the end of each year
1,500,000
Initial direct cost paid
500,000
Lease incentive received
200,000
Leasehold improvement
240,000
Purchase option that is reasonably certain to be exercised
600,000
Lease term
5 years
Useful life of building
10 years
Implicit rate
11%
PV of an ordinary annuity of 1 for 5 periods at 11%
3.70
Present value of 1 for 5 periods at 11%
0.59
1. What is the cost of the right of use asset?
a. 6,204,000
b. 6,254,000
c. 6,774,000
d. 6,304,000
2. What is the interest expense for the current year?
a. 649,000
b. 649,440
c. 749,000
d. 749,440
3. What is the lease liability at year-end?
a. 4,053,000
b. 4,053,440
d. 5,053,440
c. 5,053,000
7. PECULIAR Company, leased a machinery the following information are listed below:
Annual rental payable at the end of each year
Residual Value guarantee
Annual Executory cost paid by lessee
PV of dismantling and restoring asset
Lease term
Useful life of building
Implicit interest rate
PV of an ordinary annuity of 1 at 12% for 3 periods
PV of 1 for 3 periods at 12%
1. What is initial lease liability?
a. 4,203,510
b. 3,813,510
c. 3,600,000
2. What is the depreciation for current year?
a. 1,401,170
b. 600,501.43
c. 1,301,170
1,500,000
300,000
75,000
390,000
3 years
7 years
12%
2.40
0.7117
d. 4,403,510
d. 557,644.29
72,000
108,000
144,000
8. Norman Company entered into a nine-year lease term on a warehouse at the beginning of the year.
The lease agreement requires Norman Corp. to pay a lease payment of 550,000 annually at the end of each year.
The cost of restoring the underlying asset to its original condition as required by the contract is estimated at the
present value of 300,000.
The implicit rate is 9%. The present value of an ordinary annuity of 1 at 9% for nine years is 5.6.
What amount should be reported as lease liability?
a. 3,000,000
b. 3,080,000
c. 3,380,000
d. 3,500,000
What should be reported as cost of right of use asset?
a. 3,000,000
b. 3,080,000
c. 3,380,000
d. 3,500,000
9. Helena Company recorded the cost right of use asset at 4,500,000
The underlying asset had a useful life of 8 years and the lease term is 5 years.
The asset is expected to have a fair value of 1,500,000 at the end of 5 years and a fair value of 500,000 at the end of
8 years.
The lease agreement provided for the transfer of title of the underlying asset to the lessee at the end of the lease
term.
What amount should be depreciation expense should be recorded for the first lease term?
a. 900,000
b. 800,000
c. 600,000
d. 500,000
10. On January 2, year 1, Marlin Mining Co. (lessee) entered into a five-year lease for drilling equipment. Marlin
accounted for the acquisition as a finance lease for 240,000, which includes a 10,000 bargain purchase option. At the
end of the lease, Marlin expects to exercise the bargain purchase option. Marlin estimates that the equipment’s fair
value will be 20,000 at the end of its eight-year-life. Marlin regularly uses straight-line depreciation on similar
equipment. For the year ended December 31, year 1, what amount should Marlin recognize as a depreciation
expense on lease asset?
a. 48,000
b. 46,000
c. 30,000
d. 27,500.
11. Finance lease – Sales type
Fernan Incorporated uses leases as a method of selling its products. In early 2019, Fernan completed construction of
a passenger ferry for use between Quiapo and Guadalupe. On April 1, 2019, the ferry was leased to the Talion Ferry
line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. The
ferry is expected to be economically useful for 25 years. Annual lease payments do not include executory costs. Other
terms of the agreement are as follows:
Original cost of the ferry
Lease payments
Estimated residual value
Implicit rate
Date of first lease payment
Lease period
PV of an ordinary annuity of 1 for 20 periods at 10%
PV of an annuity due of 1 for 20 periods at 10%
PV of 1 for 20 periods at 10%
1,500,000
P225,000
P78,000
10%
April 1, 2019
20 years
8.5136
9.3649
0.1486
Based on the above and the result of your audit, determine the following.
1. Total finance income that will be earned by the lessor over the lease term
a. 2,459,306
b. 2,650,849
c. 2,392,897
2. The profit on sale to be recognized by the lessor
a. 607,103
b. 427,151
c. 415,560
d. 2,584,440
d. 618,694
3. Liability under finance lease to be reported by the lessee as of December 31, 2020
a. 1,634,616
b. 1,845,313
c. 1,858,063
d. 1,647,366
4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of December 31,
2020
a. 61,538
b. 39,194
c. 40,469
d. 60,263
5. Depreciation expense to be recognized by the lessee for the year 2019
a. 61,221
b. 55,127
c. 76,091
d. 60,873
e. 81,164
12. Finance lease – Direct financing
Billy Corporation is in the business of leasing new sophisticated computer systems. As a lessor of computers, Billy
purchased a new system on December 31, 2019. The system was delivered the same day (by prior arrangement) to
General Investment Company, a lessee. The corporation accountant revealed the: following information relating to the
lease transaction:
Cost of system to Billy
Estimated useful life and lease term
Expected residual value (unguaranteed)
Billy's –Implicit rate of interest
General’s incremental borrowing rate
Date of first lease payment
P550,000
8 years
P40,000
12%
14%
Dec. 31, 2019
Additional information is as follows:
(a)
(b)
(c)
At the end of the lease, the system will revert to Billy.(LESSOR)
General is aware of Billy's rate of implicit interest.
The lease rental consists of equal annual payments.
Based on the above and the result of your audit, answer the following: (Round off present value factors to four decimal
places.)
1. The annual lease payment under the lease is
a. 110,717
b. 95,950
c. 102,665
d. 91,664
2. The total financial revenue to be earned by the lessor over the lease term is
a. 257,600
b. 183,312
c. 271,320
d. 335,736
3. The interest income to be recognized by the lessor in 2020 is
a. 53,680
b. 52,714
c. 54,486
d. 52,547
4. The total expenses related to the lease that will be recognized by the lessee in 2020 is
a. 121,464
b. 130,792
c. 112,630
d. 119,278
5. The amount to be reported under current liabilities as liability under finance lease as of December 31, 2020 is
a. 60,239
b. 48,611
c. 35,715
d. 64,963
13. SLB
At year-end, Bain Company sold a machine with 12-year useful life to another entity and simultaneously leased it
back for one year.
Sale price
Carrying amount
Present value of reasonable lease rentals
(3,000 for 12 months @ 12%)
360,000
330,000
34,100
What amount of gain on right transferred should be reported in the current year?
a. 34,100
b. 30,000
c. 4,100
d. 0
14. SLB
At the beginning of current year, East Company 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
Carrying amount of equipment
Annual rental payable at the end of each year
Implicit interest rate
Present value of an ordinary annuity of 1 at 10% for
Four periods
6,000,000
4,500,000
800,000
10%
3.17
1. What is the initial lease liability?
a. 2,536,000
b. 3,200,000
c. 3,000,000
d. 0
2. What is the cost of right of use asset?
a. 1,902,000
b. 2,598,000
c. 2,536,000
d. 0
3. What is the gain on right transferred to the buyer-lessor?
a. 866,000
b. 634,000
c. 750,000
d. 0
4. What is the annual depreciation of the right of use asset?
a. 475,500
b. 190,200
c. 634,000
d. 253,600
5. What is the net annual rental income of the buyer-lessor?
a. 800,000
b. 200,000
c. 600,000
d. 400,000
15. SLB
At the beginning of current year, Simple Company sold a building with remaining life of 20 years and immediately
leased it back for 5 years.
Sale price at above fair value
Fair value of building
Carrying amount of building
Annual rental payable at the end of each year
Implicit interest rate
Present value of an ordinary annuity of 1 at 12%
For five periods
20,000,000
18,000,000
10,800,000
1,500,000
12%
3.60
1. What is the initial lease liability?
a. 5,400,000
b. 3,400,000
c. 7,500,000
d. 7,400,000
2. What is the cost of right of use asset?
a. 2,040,000
b. 4,000,000
c. 2,000,000
d. 3,000,000
3. What is the gain on right transferred to the buyer-lessor?
a. 7,200,000
b. 1,500,000
c. 5,600,000
d. 5,840,000
4. What is the gross rental income of the buyer-lessor?
a. 1,500,000
b. 2,000,000
c. 944,444
d. 555,596
5. What is the depreciation of the building of the buyer-lessor?
a. 1,000,000
b. 1,500,000
c. 900,000
d. 500,000
16. SLB
At the beginning of current year, Hazel Company sold a machine and immediately leased it back. The following
data pertain to the sale and leaseback transaction:
Sale price at below fair value
Fair value of machine
Carrying amount of machine
Annual rental payable at the end of each year
Remaining life of machine
Lease term
Implicit interest rate
Present value of an ordinary annuity of 1 at 6%
For 3 periods
4,000,000
4,500,000
3,600,000
500,000
10 years
3 years
6%
2.67
1. What is the initial lease liability?
a. 1,335,000
b. 1,500,000
c. 4,000,000
d. 5,000,000
2. What is the cost of right of use asset?
a. 3,600,000
b. 1,468,000
c. 1,800,000
d. 2,880,000
3. What is the gain transferred to the buyer-lessor?
a. 900,000
b. 720,000
c. 533,000
d. 500,000
4. What is the net annual rent income of the buyer-lessor?
a. 500,000
b. 150,000
c. 250,000
d. 100,000
17. At the beginning of the current year, Dyna Corporation leased computer equipment to Ram Corporation under a
direct financing lease.
The equipment has no residual value at the end of the lease and the lease does not contain bargain purchase option.
The entity wishes to earn 8% interest on a 5-year lease of equipment with a cost of P3,234,000. The present value of
an annuity due of 1 at 8% for 5 years is 4.312.
What is the total interest revenue that Dyna will earn over the lease term?
a. 1,394,000
b. 1,293,600
c. 750,000
d. 516,000
18. Doug Company entered into a five-year lease on an apartment on December 31, 2020. Lease payment of P580,000
that includes executory cost of P40,000 is to be paid annually starting December 31,2021.
The present value of the cost of restoring the underlying asset to its original condition is P350,000. The implicit interest
rate of the lease is 8%. The present value of an ordinary annuity of 1 for five years at 8% is 3.99.
1. What amount should be reported as lease liability on December 31, 2020?
a. 2,154,000
b. 2,154,600
c. 2,155,000
d. 2,155,600
2. What is the cost of the right of use asset?
a. 2,504,600
b. 2,505,000
c. 2,506,600
d. 2,507,600
19. The Melton Company purchased a machine on January 1, 2020, for 900,000 for the express purpose of leasing it. The
machine is expected to have a five-year life, no salvage value, and be depreciated on a straight-line basis. On March
1, 2020, Melton leased the machine to the Mantle Company for 300,000 a year for a four-year period ending February
28, 2024. Melton incurred total maintenance and other related costs under the provisions of the lease of 15,000 relating
to the year ended December 31, 2020. Mantle paid 300,000 to Melton on March 1, 2020.
Under the operating method, what should be the income before income taxes derived by Melton from this lease for the
year ended December 31, 2020?
a. 55,000
b. 77,000
c. 85,000
d. 100,000
20. Piaatos Company had lease an asset on finance lease. The present value of the minimum lease payment is 586,000
and the fair value of the asset is P700,000. The asset has a useful life 5 years and the lease is for the period of 4 years,
after which the asset can be acquired for a near zero cost, which is substantially below the expected value of the asset
at that date. The asset is depreciated on a straight line method. What is the amount of the annual depreciation expense?
a. 200,000
b. 140,000
c. 146,000
d. 117 200
21. On January 1, 2020 Rafaela Company leased a machine to another entity for a four-year period. The annual rentals
will be paid by the lessee beginning December 31, 2020. The lease agreement called for a 10% increase in annual
rental per annum. The rental due on December 31, 2020 was P100,000.
What is the rental income for the year ended December 31, 2020?
a. 150,000.
b. 116,025
c. 216,025.
d. 464,100.
e. 154,440
22. Odd Company entered into a financial lease to facilitate the selling of their products for this year, with a goal to
increase their sales and net income. With this, it expects to have a 15% return. It is to be noted also that at the end of
the lease term, the asset will revert to the lessor.
On January 1, 2019, the asset is leased to a lessee with the following information:
Cost of the asset
Fair value of asset
Residual value – unguaranteed
Initial direct cost
Annual rental payable in advance
Useful life and lease term
Implicit interest rate
What is the gross investment is the lease
a. 5,004,000
b. 7,800,000
c. 5,244,000
8,100,000
10,500,000
1,000,000
600,000
750,000
10 years
15%
d. 6,500,000
e. 8,500,000
23. Manny Corporation leased equipment from Weng Corporation on July 1, 2020 for an eight-year period expiring June
30,2028.
Equal payments under the lease are P600,000 and are due on July 1 of each year. The first payment was made on
July 1, 2020. The rate of interest contemplated by Manny and Weng is 10%.
The cash selling price of the equipment is P3,520,000 and the carrying amount is P2,800,000. The lease is
appropriately recorded as a sales type lease.
What amount of profit on the sale should be recorded for the year ended December 31, 2020?
a. 720,000.
b. 600,000
c. 360,000
d. 300,000
24. At the beginning of the current year, Mariposa Company sold an equipment and then immediately leased it back. The
following data pertain to the sale and leaseback transaction.
Sale price at below fair value
P3,850,000
Fair value of the machine
4,350,000
Carrying amount of machine
2,950,000
Annual rental payable at the end of each year
400,000
Lease term
3 yrs.
Implicit rate
5%
PV of ordinary annuity of 1 at 5%
2.72
What is the gain to recognized on right transferred to the buyer-lessor?
a. 920,123
b. 980,102
c. 921,103
d. 980,600
e. 888,920
25. SLB
At the beginning of current year, World Company sold a machine and immediately leased it back. The following data
pertain to the sale and leaseback transaction:
Sale price at fair value
Carrying amount of machine
Annual rental payable at the end of the year
Implicit interest rate
Present value of an ordinary annuity of 1 at
6% for 5 term)periods
Life of the asset
Lease term
1. What is the initial lease liability
a. 2,500,000
b. 2,105,000
c. 3,000,000
d. 0
5,000,000
6,000,000
500,000
6%
4.21
20 years
5 years
2. What is the cost of right of use asset?
a. 2,105,000
b. 2,526,000
c. 2,895,000
d. 1,500,000
3. What is the loss on right transferred to the buyer-lessor?
a. 508,200
b. 500,000
c. 579,000
d. 0
4. What is the net annual rent income of the buyer-lessor?
a. 373,700
b. 200,000
c. 500,000
d. 250,000
26. SLB
At the beginning of current year, Judy Company sold a building with remaining useful life of 30 years and immediately
leased it back for 5 years.
Sale price at below fair value
Fair value of building
Carrying amount of building
Annual rental payable at the end of each year
Implicit interest rate
Present value of an ordinary annuity of 1 at 12%
For 5 periods
1. What is the initial lease liability?
a. 3,600,000
b. 4,000,000
18,000,000
20,000,000
24,000,000
1,000,000
12%
3.60
c. 4,800,000
d. 0
2. What is the cost of right of use of asset?
a. 3,000,000
b. 2,880,000
c. 5,760,000
d. 6,720,000
3. What is the loss on right transferred?
a. 4,000,000
b. 2,880,000
c. 4,320,000
d. 6,000,000
4. What is the net annual rent income of the buyer-lessor?
a. 400,000
b. 200,000
c. 300,000
d. 100,000
27. Finance lease – Direct financing
In connection with your audit Billy Enterprises, you noted that the company has a long-standing policy of acquiring
company equipment by leasing. Early in 2020, the company entered into a lease for a new milling machine. The lease
stipulates that annual payments will be made for 5 years. The payments are to be made in advance on December 31
of each year. At the end of the 5-year period, Billy may purchase the machine. The estimated economic life of the
equipment is 12 years. Billy uses the calendar year for reporting purposes and straight-line depreciation for other
equipment. In addition, the following information about the lease is also available:
Annual lease payments
(including executory costs of P5,000)
Purchase option price
Estimated fair value of machine after 5 years
Implicit rate
Date of first lease payment
P60,000
P25,000
P75,000
10%
Jan. 1, 2020
QUESTIONS:
Based on the foregoing and the result of your audit, compute for the following: (Round off present value factors to four
decimal places.)
1. Amount to be capitalized as an asset for the lease of the milling machine.
a. P229,345
b. P224,017
c. P244,868
d. P275,913
2. Liability under finance lease as of December 31, 2020
a. P130,919
b. P153,855
c. P136,780
d. P189,868
3. Amount to be reported under current liabilities as liability under finance lease as of December 31, 2020
a. P39,614
b. P41,322
c. P41,908
d. P36,013
4. Interest expense for the year 2020
a. P17,435
b. P18,987
c. P16,902
d. P
0
5. Depreciation expense for the year 2020
a. P20,406
b. P19,112
c. P18,668
d. P48,974
28. Finance lease – Sales type
Talion Inc. leases equipment to its customers under noncancelable leases. On January 1, 2020, Talion leased
equipment costing P4,000,000 to Quezon Co., for nine years. The rental cost was P440,000 payable in advance
semiannually (January 1 and July 1), plus P20,000 semiannually for executory costs. The equipment had an estimated
life of 15 years and sold for P5,330,250 with an estimated unguaranteed residual value of P800,000. The implicit
interest rate is 12 percent.
QUESTIONS:
Based on the foregoing and the result of your audit, compute for the following: (Round off present value factors to four
decimal places.)
1. How much is the total interest income from lease that will be earned by Talion, Inc.?
a. P2,869,988
b. P3,389,748
c. P3,675,616
d. P
0
2. Talion, Inc. should report profit on the sale at
a. P1,330,252
b. P1,044,384
c. P1,050,012
d. P1,338,492
3. How much should be reported by Quezon Co. as liability under finance lease as of December 31, 2020?
a. P4,143,593
b. P4,446,613
c. P4,273,410
d. P
0
4. How much should be reported by Quezon Co. under current liabilities as liability under finance lease as of
December 31, 2020?
a. P356,798
b. P378,207
c. P394,252
d. P
0
5. How much interest expense should be reported by Quezon Co. in relation to the lease for the year ended
December 31, 2020?
a. P508,064
b. P501,793
c. P543,398
d. P
0