AUDITING PROBLEMS
AUDIT OF LEASE
Submitted by:
Patricio, Chan Nheth S.
Riva, Jocelyn E.
Romualdo, Christine P.
Rosco, Ivan Louise O.
San Buenaventura, Zuesette P.
AC42
Submitted to:
Marcial C. Paglinawan, CPA
September 2018
PROBLEM NO 1. Operating Lease – Comprehensive
On January 1, 2014, Alymark Co. entered into a 4-year nonrenewable operating lease,
commending on that date, for office space. The office space has a useful life of 50 years. The rent
specifies a monthly rent of P30,000.
Questions:
Assume the following independent cases:
Case No 1: Assume that no other data was given
1. How much is the total rent expense in 2014?
a. 330,000
b. 360,000
c. 410,000
d. 307,500
Answer: B
Solution:
Monthly Rent
P 30,000
(x) months
Total Rent Expense
12
P360,000
Explanation:
PAS 17, paragraph 33, provides that lease payments under an operating lease shall be recognized
as an expense on a straight-line basis over the lease term unless another systematic basis is more
representative of the time pattern of the user’s benefit.
Case No 2: Assume instead that Alymark Co. made the following payments on January 1, 2014:
Bonus to obtain Lease
200,000
One year’s rent
360,000
Last month’s rent
2. How much is the total rent expense in 2014?
a. 560,000
b. 590,000
30,000
c. 410,000
d. 360,000
Answer: C
Solution:
Annual Rent (30,000 x 12)
Amortization of Lease Bonus (200,000 ÷ 4)
Total Rent Expense
Explanation:
P360,000
50,000
P410,000
PAS 17, paragraph 33, provides that lease payments under an operating lease shall be recognized
as an expense on a straight-line basis over the lease term unless another systematic basis is more
representative of the time pattern of the user’s benefit.
The lease bonus paid by the lessee to the lessor in addition to the periodic rental is treated as
prepaid rent expense by the lessee to be amortized over the lease term.
The last month’s rent is also a prepaid rent. It is not added because it is already included in the
annual rent of 360,000.
PROBLEM NO. 2. Finance Lease with Bargain Purchase Option
On December 31, 2015, Brenet Co. signed a 5 year noncancelable lease for a new machine
requiring P100,000 annual payments beginning December 31, 2015. The machine has a useful
life of 10 years with no salvage value. The rate implicit on the lease is 10%.
Brent has a bargain purchase option amounting to 30,000. It is certain that the company will
exercise the option.
The fair value of the machine at the inception of the leased amounted to P463,422.
Questions:
Based on the above data, answer the following:
1. How much is the amount capitalized as machinery ( leased asset ) on December 31, 2015.
a. 435,617
c. 500,000
b. 587, 247
d. 530,000
Answer: A
Solutions:
Principal value of rentals (100,000 x 4.17017)
P417,617
Present value of bargain purchase option (30000 x .620)
Lease Liability- December 31, 2015
18,627
P435,617
2. How much is the interest expense in 2016?
a. Nil
c. 50,000
b. 33, 562
d. 53,000
Answer: B
Solutions:
Principal value of rentals (100,000 x 4.17017)
P 417,617
Present value of bargain purchase option (30000 x .620)
18,627
Lease Liability- December 31, 2015
P435,617
Less: First Payment
100,000
Lease Liability
P335,617
Less: Second Payment- December 31, 2016
Payment
100,000
Interest (10% x 335,617)
33,562
Principal (Current Portion)
66438
Lease Liability- December 31, 2016
P269,179
3. How much is the leased-related liability to be shown as current in the statement of financial
position on December 31, 2015?
a. 335,617
c. 66,438
b. 269, 179
d. 33,562
Answer: C
Solutions:
Current Portion
P66,438
(represented by the principal on December 31, 2016 )
4. How much is the leased-related liability to be shown as non-current in the statement of
financial position on December 31, 2015?
a. 335,617
c. 66,438
b. 269, 179
d. 33,562
Answer: B
Solution:
Non-Current Portion
269,179
Explanation:
For a finance lease, the lessee should recognize an asset and liability. The cost of the asset and
initial liability should be the lower of the fair value of the asset or the present value of minimum
lease payments. So, the total cost of the machinery is P435, 617 since it is lower than the fair
value of P463,422.
PAS 17, Paragraph 4, provides if the lessee has an option to purchase the asset at a price
that is expected to be sufficiently lower than fair value at the date the option becomes
exercisable for it to be reasonably certain, at the inception of the lease, that the option will
be exercised, the minimum lease payments comprise the minimum payments payable over
the lease term to the expected date of exercise of this purchase option and the payment
required to exercise it.
Case No. 3: Assume instead that the lessor grants free rent of 7 months
3. How much is the total rent expense in 2014?
a. 330,000
b. 360,000
c. 410,000
d. 307,500
Answer: D
Solution:
Lease Term (4 Years)
48 months
Less: Rent-free months
7 months
Number of Lease Payments
41 months
x Monthly Rental
P 30,000
Total Rents
P1,230,000
÷ Lease Term
Annual Rent Expense
4
P 307,500
Explanation:
If the lease agreement provides for a rent-free months or holiday, the total cash rental must be
determined and amortized on a straight-line basis (over the lease term of 4 years) unless another
systematic and rational basis is more appropriate (PAS 17, par 33).
4. How much is the prepaid rent (or accrued rent payable) on December 31, 2015?
a. Nil
c. (60,000)
b. (105,000)
d. (150,000)
Answer: B
Solution:
Rent Expense for two years (307,500 x 2)
P615,000
Payment for two years (30,000 x 24)
(720,000)
Accrued Rent Payable
(105,000)
Explanation:
The difference between the rent expense (lessee) or rent income (lessor) over the cash paid (lessee)
or cash received (lessor) is either a prepaid or accrued rent (lessee) or either an accrued or unearned
income (lessor).
Case No 4: Assume instead the rent payment will be as follows:
Rent per month for the first two years
25,000
Rent per month for the last two years
30,000
5. How much is the total rent expense in 2014?
a. 330,000
b. 360,000
c. 410,000
d. 307,500
Answer: A
Solution:
Rent for the first two years (25,000 x 24 months)
P600,000
Rent for the last two years (30,000 x 24 months)
720,000
Total Cash Rent
P1,320,000
÷ Lease Term
4
Annual Rental Expense
P 330,000
Explanation:
If the operating lease agreement provides for varying periodic rentals, rent expense/income should
be recognized on a straight-line basis unless a systematic and rational basis is more appropriate,
meaning, the total cash rental throughout the duration of the lease contract must be determined and
amortized over the lease term. (see PAS 17 par 33 & 50)
6. How much is the prepaid rent (or accrued rent payable) on December 31, 2015?
a. Nil
b. (105,000)
c. (60,000)
d. (150,000)
Answer: C
Solution:
Rent Expense for two years (330,000 x 2)
P660,000
Payment for two years (30,000 x 24)
(720,000)
Accrued Rent Payable
P(60,000)
Explanation:
The difference between the rent expense (lessee) or rent income (lessor) over the cash paid (lessee)
or cash received (lessor) is either a prepaid or accrued rent (lessee) or either an accrued or unearned
income (lessor).
Case No 5: Assume instead that the lessor paid the following:
Initial Direct Cost
60,000
Insurance and property tax expense
30,000
Depreciation of the leased asset
30,000
7. How much is the net income to be recognized as a result of this lease in 2014?
a. 285,000
c. 240,000
b. 360,000
d. 300,000
Answer: A
Solution:
Annual Rent Income (30,000 x 12)
P360,000
Amortization of Initial Direct Cost (60,000 ÷ 4)
(15,000)
Insurance and property tax expense
(30,000)
Depreciation of the leased asset
(30,000)
Net Income
P285,000
Explanation:
PAS 17, paragraph 52, provides that initial direct cost incurred by the lessor shall be added to the
carrying amount of the asset and recognized as expense over the lease term on the same basis as
lease income.
Case No 6: Assume that in addition to the monthly rent, the lessor and lessee agreed on the
following additional rent:
Rate
Net Sale Over
Up to
8%
1,000,000
3,000,000
5%
3,000,000
The total net sales for 2014 were 6,000,000.
8. How much is the total rent expense in 2014?
a. 670,000
b. 520,000
c. 510,000
d. 360,00
Answer: A
Solution:
Annual Rental (30,000 x 12)
P360,000
Additional Rental
*310,000
Total Rent Expense
P670,000
*Additional Rental
Net Sale over 1M up to 3M (2,000,000 x 8%)
P160,000
Net Sale over 3M (3,000,000 x 5%)
150,000
Total
P310,000
Explanation:
Periodic rentals is recognized as an expense, any contingent rentals, which are based on company
sales, should be expensed in the period they relate.
PROBLEM NO. 3. With Guaranteed Residual Value and Initial Direct Cost
On December 31, 2015, Kasibu Co. signed a 4-year, non-cancelable lease for a new machine
requiring P130,000 annual payments beginning December 31, 2015. The annual payments
include payment for insurance and property taxes amounting to P10,000. On the same date,
Kasibu Co. paid incremental costs that are directly attributable to negotiating and arranging a
lease. The machine has a useful life of 10 years, with no residual value. The rate implicit on the
lease is 10%.
Kasibu Co. guarantees a residual value of P30,000 at the end of the lease term. The fair value of
the machine at the inception of the lease amounted to P466,934.
Questions:
Case 1: Based on the above data, answer the following:
1. How much is the amount to be capitalized as machinery (leased asset) on December 31,
2015?
a. 438,918
c. 458,918
b. 495,975
d. 488,918
Answer: C
Solution:
Present value of an ordinary annuity of 1 at 10% for 4 periods
Present Value of 1 at 10% for 4 periods
Annual Payment
Advance payment
130,000
PV of rentals (130,000x2.48685)
323,290
Less: Property Taxes
1st annual payment
10,000
PV of Insurance and property taxes 24,868
(10,000x2.48685)
Lease Liability-December 31,2015
2.48685
0.68301
P453,290
(34,868)
P418,422
Indirect Cost
Present Value of Guaranteed Residual Value (30,0000x0.68301)
Minimum Lease Payment
20,000
20,490
P458,918
Explanation:
For a finance lease, the lessee should recognize an asset and liability. The cost of the asset and
initial liability should be the lower of the fair value of the asset or the present value of minimum
lease payments. So, the total cost of the machinery is P458,918 since it is lower than the fair
value of P466,934.
2. How much is the interest expense in 2016?
a. Nil
b. 31,892
c. 45,892
d. 48,892
Answer: B
Solution:
Date
12/31/15
12/31/15
12/31/16
Payment
Interest
Principal
130,000
130,000
31,892
130,000
98,108
Present Value
458,918
328,918
230,810
12/31/17
12/31/18
12/31/19
130,000
130,000
130,000
23,081
12,389
23,720
106,919
117,611
6,280
123,891
6,280
-
Interest (2016) = 318, 918x10% = P31, 912
3. How much is the lease-related liability to be shown as current in the statement of
financial position on December 31, 2015?
a. 318,918
c. 88,108
b. 230,810
d. 31,892
Answer: C
Solution:
Annual Rental
Less: Interest Expense -2015
Total Liabilities,net of tax (12/31/15)
Less: Annual Payment
Total Liabilities (12/31/15)
X Effective Interest Rate
Current Portion
P130,000
P448,918
130,000
318,918
10%
(31,892)
P88,108
4. How much is the lease-related liability to be shown as noncurrent in the statement of
financial position on December 31, 2015?
a. 318,918
c. 88,108
b. 230,810
d. 31,892
Answer: B
Solution:
Carrying Amount(12/31/15)
Less: Principal Amount
Annual Payment
P130,000
Interest Expense
(31,892)
Carrying Amount (Non-current Portion)
P328,918
98,108
P230,810
Explanation:
PAS 17, par 23: “It is not appropriate for liabilities for leased assets to be presented in the
financial statements as a deduction from leased assets. If for the presentation of liabilities on the
face of the balance sheet a distinction is made between current and non-current liabilities, the
same distinction is made for lease liabilities.”
Case 2: Assume instead that the fair value of the machine at the inception of lease amounted to
P430,122:
5. How much is the amount to be capitalized as machinery (leased asset) on December 31,
2015?
a. 438,918
c. 458,918
b. 430,122
d. 450,122
Answer: D
Solution:
Fair Value
Direct Cost
Net investment in the lease
P430,122
20,000
P450,122
Explanation:
Since the net investment in the lease is lesser than the minimum lease payment of P458,918, the
total cost of the leased machine is P450,122.
6. How much is the interest expense in 2016?
a. Nil
b. 31,892
Answer: D
Solution:
Interest Expense P310,122x11.5%= P35,664
c. 52,776
d. 35,664
7. How much is the lease-related liability to be shown as current in the statement of
financial position on December 31, 2015?
a. 84,336
c. 310,122
b. 88,108
d. 225,786
Answer: A
Solutions:
Annual Rental
Less: Interest Expense -2015
Total Liabilities,net of tax (12/31/15)
Less: Annual Payment
Total Liabilities (12/31/15)
X Effective Interest Rate
Current Portion
P130,000
P450,122
130,000
310,122
11.5%
(35,664)
P84,336
8. How much is the lease-related liability to be shown as noncurrent in the statement of
financial position on December 31, 2015?
a. 84,336
b. 88,108
c. 310,122
d. 225,786
Answer: D
Solution:
New implicit rate: 11.50% (calculated through interpolation)
Date
Payment
Interest
Principal
12/31/15
Present Value
P450,122
12/31/15
130,000
-
130,000
310,122
12/31/16
130,000
35,664
84,336
225,786
Carrying Amount (12/31/15)
Less: Principal Amount
130,000
Interest Expense
35,664
Noncurrent Portion
P310,122
84,336
P225,786
Explanation:
PAS 17, par 23: “It is not appropriate for liabilities for leased assets to be presented in the
financial statements as a deduction from leased assets. If for the presentation of liabilities on the
face of the balance sheet a distinction is made between current and non-current liabilities, the
same distinction is made for lease liabilities.”
PAS 17, par 38: “Initial direct costs are often incurred by lessors and include amounts such as
commissions, legal fees and internal costs that are incremental and directly attributable to
negotiating and arranging a lease. For finance leases other than those involving manufacturer or
dealer lessors, initial direct costs are included in the initial measurement of the finance lease
receivable and reduce the amount of income recognised over the lease term. The interest rate
implicit in the lease is defined in such a way that the initial direct costs are included
automatically in the finance lease receivable; there is no need to add them separately. Costs
incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease
are excluded from the definition of initial direct costs. As a result, they are excluded from the net
investment in the lease and are recognised as an expense when the selling profit is recognised,
which for a finance lease is normally at the commencement of the lease term.”
The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to
pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the
lessee would incur to borrow over a similar term, and with a similar security, the funds necessary
to purchase the asset.
PROBLEM NO. 4. Finance Lease – Depreciation
On December 31, 2014, Bakun Co. signed a 4-year noncancelable finance lease for a new machine
for P438,918. The machine has a useful life of 10 years. Bakun regularly uses straight line
depreciation on similar asset.
Assume that the cost of the machine includes P30,000 gross bargain purchase option.
Questions:
Based on the above data, answer the following:
Case No 1: At the end of the lease, Bakun expects to exercise the bargain purchase option. Bakun
estimates that the equipment’s fair value will be P50,000 at the end of its useful life.
1. How much is the depreciation expense on December 31, 2015?
a. 38,892
c. 41,843
b. 102,230
d. 97,230
Answer: A
Solution:
Cost of Leased Equipment
Less: Estimated Fair Value/Salvage Value
Depreciable Cost
÷ Useful Life of the Asset
Depreciation Expense
P438,918
50,000
P388,918
10
P 38,892
Explanation:
Depreciation on Leased Assets will depend on how the lease qualifies as a finance lease:
a. If the lease transaction met the criterion as either transferring ownership or containing a bargain
purchase option. The asset is deprecated over the estimated useful life of the asset.
b. If the transaction qualifies as finance lease because it met either the major part of useful life
criterion or because the present value of minimum lease payments represented substantially all of
the fair value of the underlying asset, it must be depreciated over the lease term or llife of the asset,
whichever is shorter.
The Finance Lease Transaction met the Bargain Purchase Criterion; hence depreciation is based
on the useful life of the Asset.
Case No 2: Assume instead that the cost of the machine include P30,000 gross guaranteed residual
value.
2. How much is the depreciation expense on December 31, 2015?
a. 38,892
c. 41,843
b. 102,230
d. 97,230
Answer: B
Solution:
Cost of Leased Equipment
Less: Guaranteed Residual Value
Depreciable Cost
÷ Lease Term
Depreciation Expense
P438,918
30,000
P408,918
4
P102,230
Explanation:
The guaranteed Residual Value is deducted from cost in determining depreciable amount because
the machine will revert back to the lessor upon the lease expiration.
The lease term of 4 years is used in computing depreciation because there is no bargain purchase
option and no transfer of title.
PROBLEM NO.5. Computation of Periodic Lease Payments
On January 1, 2015, Benguet Co. leased an asset with a fair value of P4,000,000 from Viscaya
Co. for a lease term of 4 years. The lease specifies equal annual payments beginning on January
1, 2015. The lease gurantees a P1,500,000 residual value of the asset the end of the lease term.
The rate implicit on the lease is 10%.
How much is the annual lease payment?
a. 938,673
b. 853,337
c. 823,949
d. 906,347
Answer: B
Solution:
Cost
PV of Residual Value (1,500,000x0.68301)
Net Investment to be recovered from rentals
Divided by: PV of annuity due of 1 at 10% for 4 periods
Annual Rentals
P4,000,000
(1,024,520)
P2,975,479
÷ 3.4869
P 853,337
Explanation:
Annual Rental is derived from deducting the Present Value of Residual Value from the Cost of
the leased property and dividing the difference by its PV factor.
PROBLEM NO. 6. Finance Lease (Lessor)
On December 31, 2015, San Carlos Co. leased an equipment with a cost of P4,000,000 to
Urdaneta Co. for 5 years which is also the useful life of the asset. The lease agreement specifies
equal annual payment of P914,585 beginning on December 31, 2015.
At the end of the lease term, the equipment will revert to Carlos Co. A third parted related to the
lease guarantees residual value of the equipment amounting to P300,000. The rate implicit on the
lease is 10%.
Questions:
Based on the above data, answer the following.
1. How much is the total interest income to be earned over the leased term?
a. 827,927
c. 272, 927
b. 572,927
d. 1,172,927
Answer: A
2. How much is the interest expense in 2016?
a. 308,541
c. 247,937
b. 400,000
d. 109,216
Answer: A
3. How much is the leased-related asset to be shown as current in the statement of financial
position on December 31, 2015?
a. 3.085,415
c. 2,479,370
b. 606,044
d. 4,000,000
Answer: B
Solution:
Date
12/31/2015
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
Payment
914585
914585
914585
914585
914585
300000
Interest
0
308541
247930
181254
107930
27272
872927
Principal
914585
606044
666645
733331
806655
272728
Present Value
4000000
3085415
2479371
1812720
1079400
272728
0
Explanation:
The annual rental is payable in advance on December 31 of each year starting December 31,
2015.
Since the residual value is guaranteed, the machinery will revert to the lessor at the end of the
lease term.
Interest is equal to the preceding present value times the interest rate. The first rental payment on
December 31, 2015 pertains to principal only.
Thus on December 31, 2016, the interest is equal to 3085415 times 10% or 308541. This interest
income pertains to 2016.
Principal is the portion of the rental payment minus the interest. Thus, on December 31, 2016,
914585 minus 308,541 equals to 606,044 which is the leased-related asset to be shown as
current in the statement of financial position on December 31, 2015.
The present value is the balance of the present value minus the principal. Thus on December 31,
2016, 3,085,415 minus 606,044 equals 2,479,371.
PAS 17, Paragraph 4, Guaranteed residual value for a lessor, that part of the residual value that is
guaranteed by the lessee or by a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.
PROBLEM NO. 7. Direct Financing Lease-With Initial Direct Cost
On December 31, 2015, Dagupan Co. leased an equipment with a cost of P4,000,000 to Josiah
Co. for 5 years which is also the useful life of the asset. The lease agreement specifies equal
annual payment of P959,256 beginning on December 31, 2015. On the same date, Dagupan Co.
paid P66,956 incremental cost that are directly attributable to negotiating and arranging a lease.
At the end of the lease term, the equipment will revert to Dagupan Co.
The rate implicit on the lease is 10% but after considering the initial direct cost the implicit rate
is adjusted at 9%.
Questions:
Based on the above data, answer the following.
1. How much is the total interest income to be earned over the leased term?
a.729,322
c. 1,208,975
b. 796, 278
d. 1,275,931
Answer: A
2. How much is the interest expense in 2016?
a. 304,074
c. 238,556
b. 400,000
d. 279,693
Answer: D
3. How much is the leased-related asset to be shown as current in the statement of financial
position on December 31, 2015?
a. 3,040, 744
c. 2,385, 563
b. 655, 181
d. 679,563
Answer: D
Solutions:
Date
12/31/2015
12/31/2016
12/31/2017
12/31/2018
12/31/2019
Payment
959256
959256
959256
959256
959256
Interest
0
279693
218540
151880
79209
729322
Principal
959256
679563
740716
807376
880047
Present Value
4066956
3107700
2428137
1687421
880047
0
Explanation:
The annual rental is payable in advance on December 31 of each year starting December 31,
2015.
Interest is equal to the preceding present value times the interest rate. The first rental payment on
December 31, 2015 pertains to principal only.
Thus on December 31, 2016, the interest is equal to 3,107,700 times 9% or 279,693. This
interest income pertains to 2016.
Principal is the portion of the rental payment minus the interest. Thus, on December 31, 2016,
959,256 minus 279,693 equals to 679,563 which is the leased-related asset to be shown as
current in the statement of financial position on December 31, 2015.
The present value is the balance of the present value minus the principal. Thus on December 31,
2016, 3,107,700 minus 679,563 equals 2,428,137
PAS 17, Paragraph 38 provides that initial direct costs are often incurred by lessors and include
amounts such as commissions, legal fees and internal costs that are incremental and directly
attributable to negotiating and arranging a lease.. The interest rate implicit in the lease is defined
in such a way that the initial direct costs are included automatically in the finance lease
receivable; there is no need to add them separately. Costs incurred by manufacturer or dealer
lessors in connection with negotiating and arranging a lease are excluded from the definition of
initial direct costs. As a result, they are excluded from the net investment in the lease and are
recognised as an expense when the selling profit is recognised, which for a finance lease is
normally at the commencement of the lease term.
PROBLEM NO. 8.
WASTED TIME, a dealer of machinery and equipment entered as a lessor on the following lease:
First Lease
On January 1, 2006, a machinery was leased to another enterprise with the following provisions:
Annual rental payable at the end of each year
Lease term and useful of machinery
Cost of machinery
Residual value- unguaranteed
Implicit interest rate
PV of an ordinary annuity of 1 for 5 periods at 12%
PV of 1 for 5 periods at 12%
3,000,000
5 years
8,000,000
1,000,000
12%
3.60
0.57
At the end of the lease term on December 31,2010, the machinery will revert to WASTED TIME.
The perpetual inventory system is used. WASTED TIME incurred initial direct cost of P300,000
in finalizing the lease agreement. The lease is appropriately recorded as sales type lease.
Second Lease
TEQUILA SUNRISE Company leased equipment from WASTED TIME Co on July 1,2006 for
an eight-year period expiring June 30, 2013. Equal payments under the lease are P1,200,000 and
are due on July 1 of each year. The first payment was made on July 1,2006. The rate of interest
contemplated by TEQUILA SUNRISE and WASTED TIME is 10%. The cash selling price of the
equipment is P7,040,000 and the cost of the equipment on WASTED TIME’s accounting records
is P5,600,000. The lease is appropriately recorded as sales type lease.
Questions:
Based on the above and the result of your audit, determine the following:
1. The total financial revenue on the first lease?
a. 4,630,000
c. 5,200,000
b. 4,200,000
d. 3,630,000
Answer: A
Solutions:
Gross rentals (P 3,000,000 x 5)
Unguaranteed residual value (URV)
Gross Investment
P 15,000,000
1,000,000
PV of Gross rentals (P 3,000,000 x 3.6)
PV of URV (P 1,000,000 x 0.57)
Net investment
P 10,800,000
570,000
P 16,000,000
Unearned Interest Income
P 11,370,000
P 4,630,000
Explanation:
In reference to PAS 17, paragraph 4,the unearned finance income is the difference between:
(a) the gross investment in the lease which is the aggregate of:
o the minimum lease payments receivable by the lessor under a finance lease, and
o any unguaranteed residual value accruing to the lessor, and
(b) the net investment in the lease which is the gross investment in the lease discounted at the
interest rate implicit in the lease
Unguaranteed residual value is that portion of the residual value of the leased asset, the realization
of which by the lessor is not assured or is guaranteed solely by a party related to the lessor.If there
has been a reduction in the estimated unguaranteed residual value, the incomeallocation over the
lease term is revised and any reduction in respect of amounts accrued is recognized immediately.
2. The profit on sale in 2006 on the first lease
a. 7,700,000
c. 2,500,000
b. 3,070,000
d. 3,370,000
Answer: B
Solution:
Sales
PV of URV
P 11,370,000
570,000
P 10,800,000
Cost of Machinery
PV of URV 570,000
Initial Direct Cost
8,000,000
(7,430,000)
(300,000)
Gross Profit
P 3,070,000
Explanation:
In reference to PAS 17, paragraph 44, the sales revenue recognized at the commencement of the
lease term by dealer lessor is thefair value of the asset, or, if lower, the present value of the
minimum lease payments accruing to the lessor, computed at a market rate of interest or simply
the net investment. The cost of sale recognized at the commencement of the lease term is the cost,
or carrying amount if different, of the leased property less the present value of the unguaranteed
residual value.
The difference between the sales revenue and the cost of sale is the selling profit.
3. The earned financial revenue or interest income for 2006 on the first lease
a. 1,364,400
c. 1,800,000
b. 1,296,000
d. 926,000
Answer: A
Solution:
PV 1/1/06
Interest
Interest Income
P 11,370,000
x
12%
P 1, 364,400
4. The profit on sale for the year 2006 on the second lease
a. 720,000
c. 90,000
b. 1,440,000
d. 45,000
Answer: B
Solution:
Sales (P 1,200,000 x 5.8685*)
Cost of Equipment
Profit
P 7,042,200
5,600,000
P 1,442,200
* PV of Annuity Due
5. The interest revenue for the year 2006 on the second lease
a. 292,000
c.176,000
b. 352,000
d.146,000
Answer:A
Solution:
PV 7/1/06
1st Rental payment
Balance
P 7,042,200
(1,200,000)
5, 842,400
Interest (July to December, 6/12 x 12%)
Interest revenue
x
0.06
P 292,120
PROBLEM NO.9. Sale and Leaseback as Finance Lease
a. The following data relate to a sale and leaseback of equipment of TimMalna Co.
December 31, 2015:
Sales Price
2,162,880
Cost of Equipment
2,000,000
Accumulated Depreciation
100,000
Annual Rent Payable
600,000
Estimated Remaining Life
5
Lease term
5
Implicit rate
12%
What amount of gain on the sale should TimMalna Co. recognized immediately as of December
31, 2015?
a. Nil
c. 162,880
b. 262,880
d. 837,120
Answer: A
Explanation:
The answer is 0. The sale and leaseback is a finance lease. It meets the criterion that lease
term is for a major part of the economic life of the asset.
PAS 17, par 50.: If a sale and a leaseback transactions result in finance lease, any excess
of sales proceeds over the carrying amount should not be immediately recognized as
income in the financial statements of a seller-lessee. Instead, it is being deferred and
amortized over the lease term.
Problem No. 10. Sale and Leaseback as Operating Lease – Treatment of Gain
The following data relate to a sale and leaseback of equipment of TimMakder Co. on
December 31,2015:
Sales Price
Cost of equipment
Accumulated depreciation
Annual rent payable
Estimated remaining life
Lease term
1,400,000
1,800,000
800,000
40,000
8
4
Questions:
Based on the above data, answer the following:
1. Assuming that the fair value amounted to P1,400,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil
c. 300,000
b. 400,000
d. 100,000
Answer: B
Solution:
FV
CA
Gain
P 1,400,000
(1,000,000)
P 400,000
Explanation:
In reference to PAS 17, paragraph 61, if the leaseback is an operating lease, and the lease
payments and the sale price are at fair value, there has in effect been a normal sale
transaction and any profit or loss is recognized immediately.
The transaction is established at fair value when the fair value and selling price are equal.
2. Assuming that the fair value amounted to P1,500,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil
c. 300,000
b. 400,000
d. 100,000
Answer: B.400,000
SP
CA
Gain
P 1,400,000
(1,000,000)
P 400,000
In reference to PAS 17, paragraph 61, if the sale price is below fair value, any profit or loss
shall be recognizedimmediately; and if the sale price is below fair value but the fair value
is above the carrying amount, the excess of fair value over the carrying amount (P 100,000)
is not recognized.
3. Assuming that the fair value amounted to P1,100,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil
c. 300,000
b. 400,000
d. 100,000
Answer: D.100,000
FV
CA
Gain
P 1,100,000
(1,000,000)
P 100,000
In reference to PAS 17, paragraph 61, if the sale price is above fair value, the excess over
fair value shall be deferred and amortized over the period for which the asset is expected
to be used.
The difference of the fair value and selling price of P 300,000 is a deferred gain that is to
be amortized in proportion to lease payments.
Problem No. 11. Sale and Leaseback as Operating Lease – Treatment of Loss
The following data relate to a sale and leaseback of equipment of TimMackey Co. on
December 31, 2015:
Sales Price
Cost of equipment
Accumulated depreciation
Annual rent payable
Estimated remaining life
Lease term
900,000
1,800,000
800,000
40,000
8
4
Questions:
Based on the above data, answer the following:
1. Assume that the fair value amounted to P900,000, what amount of loss on the sale
should TimMackey Co recognized immediately as of December 31,2015?
a. Nil
c. (200,000)
b. (100,000)
d. (150,000)
Answer: B
Solution:
FV
CA
Loss
P 900,000
(1,000,000)
(P 100,000)
Explanation:
In reference to PAS 17, paragraph 63, for operating leases, if the fair value at the time of a
sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to
the amount of the difference between the carrying amount and fair value shall be
recognized immediately.
2. Assume that the fair value amounted to P1,000,000, what amount of loss on the
sale should TimMackey Co recognized immediately as of December 31,2015?
a. Nil
c. (200,000)
b. (100,000)
d. (150,000)
Answer: B. (100,000)
SP
CA
Loss
P 900,000
(1,000,000)
(P 100,000)
In reference to PAS 17, paragraph 61, if the sale price is below fair value, any profit or
loss shall be recognized immediately.
3. Assume that the fair value amounted to P1,000,000 and any loss will be
compensated by below-market future rentals, what amount of loss on the sale
should TimMackey Co recognized immediately as of December 31,2015?
a. Nil
c. (200,000)
b. (100,000)
d. (150,000)
Answer: A
Solution:
SP
CA
Deferred Loss
P 900,000
(1,000,000)
(P 100,000)
Explanation:
In reference with to PAS 17, paragraph 61, if the sale price is below fair value, any profit
or loss shall be recognized immediately except that, if the loss is compensated for by future
lease payments at below market price, it shall be deferred and amortized in proportion to
the lease payments over the period for which the asset is expected to be used.
No immediate loss. The P 100,000 deferred loss will be amortized in proportion to lease
payments.
PROBLEM NO. 12.
You were engaged in the annual examination of the financial statements of TimMalna
Co. As part of your Audit, you are assigned for the lease and its related account. The
following accounts appear in the ledger:
1/1/2015
Building (Leased Asset)
1,351,805 1,351,805
12/31/2015
12/31/2015
Bal. End, 12/31/2015
Lease Liability
84,419 1,351,805
1,066,986
1/1/2015
Interest Expense
12/31/2015
115,181
Bal. End
115,181 12/31/2015
Depreciation Expense
12/31/2015
135,181
Bal. End
135,181 12/31/2015
Additional Information:
•
The January 1, 2015 balance reflects the amount capitalized on December 31,
2014 when TimMalna Co. leased a building from TimDuncan Co. for a lease term
of 10 years. The building has a useful life of 20 years. There is no transfer of
ownership at the end of the leased asset’s useful life and the fair value of the
building on December 31, 2014 was p 2,000,000. TimMalna Co’s incremental
borrowing rate is 10%. Lease payment of P200,000 is due every December 31,
starting December 31, 2014.
•
The beginning balance of the lease liability reflects the amount that was
capitalized on December 31, 2014 less the first payment made on that date.
•
The debit entries on December 31, 2015 in the leased liability and interest
expense reflected the amount paid on that date.
•
Depreciation expense was also recorded using straight line method.
Questions:
Based on the above data, answer the following:
Case No. 1 : Assume no other data are given, answer the following:
1. How much is the amount to be capitalized as building (leased asset) on December 31,
2014?
a. Nil
c. 2,000,000
b. 1,351,805
d. 1,551,805
Answer: A
Explanation:
The lease is an operating lease since there is no transfer of ownership at the end of the
term. Hence, operating lease expenses the lease payments immediately, a capitalized
lease delays recognition of the expense.
PAS 17, paragraph 33, provides that “lease payments under an operating lease shall be
recognized as an expense on straight line basis over the lease term unless another
systematic basis is representative of the time pattern of the user’s benefit”
2. How much is the total lease related expenses in 2015?
a. 290,361
c. 580,000
b. 200,000
d. 250,362
Answer: B
Explanation:
PAS 17, paragraph 33 and 50, provides that the total rentals in an operating lease shall be
recognized by the lessor and lessee as an expense on a straight line basis over the lease
term unless another systematic basis representative of the time pattern of the user’s
benefit.
3. How much is the current liabilities as of December 31, 2015?
a. Nil
c. 93,301
b. 200,000
d. 49,638
Answer: A
4. How much is the total leased related liabilities as of December 31, 2015?
a. Nil
c. 71,301
b. 1,066,986
d. 1,215,685
Answer: A
For number 3 and 4. There will be no liability recognisesd since the lease is under operating
lease.
According to PAS 17, paragraph 20 " Initial recognition for finance lease, At the
commencement of the lease term, lesses shall recognise finance leases as assets and
liabilities in their statements of financial position at amounts equal to the fair value of the
leased property or, if lower, the present value of the minimum lease payments, each
determined at the inception of the lease. the discount rate to be used in calculating the
present value of the minumun lease payments is the interest rate implicit in the lease, if this
is practicable to determine; if not, the lessee's incremental borrowing rate shall be used.
any initial direct costs of the lessee are added to the amount recognised as an asset."
Case 2 Assume instead that the fair value of the asset is P 1,500,000.
1. How much is the amount to be capitalized as building (leased asset) on December 31,
2014?
a. Nil
c. 2,000,000
b. 1,351,805
d. 1,551,805
Answer: B
Solution:
to get ordinary annuity in advance:
1-(1+R)-n X 1 + R
R
1-(1.10)-10 X 1.10
10
= 6.1446 X 1.10
= 6.7590
Present Value of rental payments ( 6.7590 X P200,000) = 1,351, 805
Explanation:
According to PAS 17, paragraph 20 " Initial recognition for finance lease, At the
commencement of the lease term, lesses shall recognise finance leases as assets and
liabilities in their statements of financial position at amounts equal to the fair value of the
leased property or, if lower, the present value of the minimum lease payments, each
determined at the inception of the lease. the discount rate to be used in calculating the
present value of the minimum lease payments is the interest rate implicit in the lease, if this
is practicable to determine; if not, the lessee's incremental borrowing rate shall be used.
any initial direct costs of the lessee are added to the amount recognised as an asset."
2. How much is the total lease related expenses in 2015?
a. 290,361
c. 580,000
b. 200,000
d. 250,362
Answer: D
Solution:
Depreciation Expense
P 135,181.00
Interest Expense
115,181.00
Total Expenses
250, 362.00
3. How much is the current liabilities as of December 31, 2015?
a. Nil
c. 93,301
b. 200,000
d. 49,638
Answer: C
Solution:
Principal payment on 12/31/15
Total payment in 2015
P 200,000
Less: Applicable to interest
106,699
(1,066,986 X 10%)
93,301
4. How much is the total leased related liabilities as of December 31, 2015?
a. Nil
c. 71,301
b. 1,066,986
d. 1,215,685
Answer: B
Solution:
1/1/2015
12/31/2015
Interest
income
Interest
Expense
Applicable to
Capital
Carrying Amount
200,000
115,181
84,819
1,151,805
1,066,986