Mindanao State University

College of Business Administration and Accountancy

DEPARTMENT OF ACCOUNTANCY
Marawi City

FINANCE LEASE – LESSEE

Accounting 122
TRUE OR FALSE. Determine whether the following statements are correct or not with regards to
finance leases. Write A if the statement is correct and write B if not. Final answers should be
written on the answer sheet provided with this questionnaire. Erasures are strictly not allowed.
1. The inception of the lease is the earlier of the date of the lease agreement or the date of
the commencement of the lease. B
2. The initial recognition of the assets, liabilities, income or expenses resulting from the lease is
to be made on the date from which the lessee is entitled to exercise its rights to use the
leased asset. A
3. The lessee having the ability to continue the lease for a secondary period at a rent which
is substantially lower than the market rate is one of the situations that would normally lead
to a lease being classified as a finance lease. B
4. Under PAS 17, “major part” means at least 75% of the life of an asset. B
5. At the commencement of the lease, the lessee shall recognize a finance lease as asset
and liability at an amount equal to the fair value of the leased asset or the present value
of the minimum lease payments, whichever is lower plus any initial direct costs incurred. B
6. The minimum lease payments exclude any amount guaranteed solely by a party related
to the lessor. A
7. Contingent rent, which is the portion of the lease payment that is not fixed in amount but
is based on factor other than just the passage of time, and executory costs are expensed
immediately when incurred. A
8. The interest rate implicit in the lease is the discount rate that causes the aggregate
present value of the minimum lease payments and the guaranteed residual value to
equal the fair value of the leased asset and initial direct costs of the lessee. B
9. If there is reasonable certainty that the lessee will obtain ownership by the end of the
lease term, the depreciation of the leased asset is based on the useful life of the asset or
lease term whichever is longer. B
10. A land lease with a lease term of several decades or longer may be classified as a
finance lease even if title will not pass to the lessee at the end of the lease term. A
11. The classification of the lease is normally carried out at the commencement of the lease.
B
12. When a lease includes both land and building, an entity shall determine the classification
of the land lease and building lease based on the classification criteria taking into
account that land normally has an indefinite economic life. A
13. When there is a lease of land and building and the title to the land is not transferred,
generally, the lease is treated as if the land is an operating lease and the building is a
finance lease. A
14. The lessee’s carrying amount of an asset from the capitalization of a lease would be
periodically reduced by the portion of the minimum lease payment allocable to
reduction of the lease liability. B
15. The classification of a lease as either operating or finance lease is based on the length of
the lease and the economic life of the asset. B
16. If the present value of the minimum lease payments is 50% of the fair value of the asset,
then this situation would lead prima facie to the classification of a lease as operating
lease. A
17. In determining the lessee’s capitalizable cost at the beginning of the lease term, the
payment called for by the bargain purchase option would be added at its exercise price.
B
18. The three types of period costs that a lessee experiences with finance lease are initial
direct costs, interest expense and executory costs. B
19. The lease term includes all periods for which failure to renew imposes a penalty sufficiently
high that the lessee probably will renew. A
20. For a finance lease, the amount recorded initially by the lessee as asset should not
exceed the fair value of the leased property at the inception of the lease. B
21. The accounting concept that is principally used to classify leases into operating or
financing is substance over form. A
22. If the residual value of a leased asset is greater than the amount guaranteed by the
lessee, the lessor would pay the lessee for the difference. B

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 1
 23. The present value of the minimum lease payments should be used by the lessee in the
determination of the finance lease liability but not the operating lease liability. A
24. If a lessee is required to pay equal annual payments in a 10 year finance lease, the
reduction of the liability in Year 2 should equal the current liability shown for the lease at
the end of Year 1. A
25. A general description of the lessee’s leasing arrangements is a required disclosure in a
finance lease on the part of the lessee. B

SHORT PROBLEMS. Compute for the amount/s asked by each problem. Round off present value
factors to four decimal places. Final answers should be written on the answer sheet provided
with this questionnaire. Solutions are to be written in a separate sheet of paper to be submitted
along with the answer sheet. Erasures are strictly not allowed.
PROBLEM 1: Troy Company prepared the following amortization schedule for the lease of a
machine from another entity. The machine has an economic life of six years. The lease
agreement requires four annual payments of P660,000 including executory costs of P60,000 and
the machine will be returned to the lessor at the end of the lease term.
Minimum Interest Reduction Balance
Date Lease Payment Expense of Liability of Liability
1/1/2011 P 1,970,300
12/31/2011 P 600,000 P 197,030 P 402,970 1,567,330
12/31/2012 600,000 156,732 443,268 1,124,062
12/31/2013 600,000 112,406 487,594 636,468
12/31/2014 700,000 63,532 536,468 100,000
1. What amount would Troy Company disclose as future lease payments in its notes to
financial statements on December 31, 2011? 437,500
2. Prepare the entry to record the finance lease on January 1, 2011. 4,006,500
3. How much annual depreciation expense would Troy record? 85,000
PROBLEM 2: East Company leased a new machine from North Company on January 1, 2011
under a lease with the following information:
Annual rental payable at the beginning of each lease
year P 400,000
Lease term 10 years
Useful life of the machine 12 years
Implicit interest rate 14%
Incremental borrowing rate of the lessee 12%
Initial direct costs 100,000
East Company has the option to purchase the machine on January 1, 2021 by paying P500,000
which approximates the expected fair value of the machine on the option exercise date.
4. At the commencement of the lease, what amount should be recognized as finance lease
liability? 9,750
5. What would be the carrying amount of the leased asset in the records of East Company as
of December 31, 2013? 330,000
6. The balance of the finance lease liability as of December 31, 2014 is: 0 (25,000 net
payable)
PROBLEM 3: Casanova Company leased a warehouse with adjoining land for a period of 15
years starting April 1, 2011. The fair values of the leasehold interests in the land and the
warehouse are P5,000,000 and P2,500,000, respectively. The land has an indefinite economic life
whereas the warehouse has a useful life of 15 years. Title to the land is not expected to pass at
the end of the lease. Annual rentals of P900,000 are payable in advance every April 1 of each
year.
7. What amount should Casanova recognize as an operating lease expense in 2011? 650,000
8. The total amount of assets that would be recognized by Casanova Company in relation to
the lease as of December 31, 2011 is: 2,620,000
PROBLEM 4: On January 1, 2011, Stoic Company became the lessee of new equipment under a
non-cancelable six year lease. The estimated economic life of this equipment is ten years. The
fair value of this equipment on January 1 was P4,000,000. The lease does not meet the criteria for
classification as a finance lease with respect to transfer of ownership of the leased asset or
bargain purchase option or lease term.
Nevertheless, Stoic classified this lease as a finance lease because the present value of the
minimum lease payments amounts to substantially all of the fair values of the asset at the

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 2
inception of the lease. The interest rate implicit in the lease was 12% and the incremental
borrowing rate of Stoic was 10%. No residual value was guaranteed by Stoic or a party related to
Stoic.
9. The annual lease payments (excluding executory costs) of Stoic under the lease
agreement would have not been lower than: 50,000
PROBLEM 5: Macedon Company leases many of its assets and capitalizes most of the leased
assets. On December 31, 2011, the entity had the following balances in relation to a piece of
specialized equipment:
Equipment under finance lease P 4,000,000
Accumulated depreciation 2,465,000
Lease liability 1,300,000
Depreciation has been recorded up to the end of the year and no accrued interest is involved.
On December 31, 2011, Macedon Company decided to purchase the equipment for P1,600,000
and paid cash to complete the purchase.
10. What is the cost of the actual purchase of the leased equipment? 232,050
PROBLEM 6: On December 31, 2011, Action Company signed a 7 year finance lease for an
airplane to transport its basketball team around the country. The airplane’s fair value was
P8,415,000. Action made the first annual lease payment of P1,530,000 on December 31, 2011.
Action’s incremental borrowing rate was 12% and the interest rate implicit in the lease known to
Action was 9%.
11. What amount should Action report as finance lease liability in its December 31, 2011
statement of financial position? 32,050
PROBLEM 7: On January 1, 2011, Nets Company entered into a lease contract with Denver
Company for a new equipment that had a selling price of P2,120,000. The lease contract
provides that annual lease payments of P420,000 will be made for 6 years. Nets made the first
payment on January 1, 2011, subsequent payments are made on December 31 of each year.
Nets guarantees a residual value of P367,122 at the end of the lease term. After considering the
guaranteed residual value, the rate implicit in the lease is determined to be 12%. Nets has an
incremental borrowing rate of 15%. The economic life of the equipment is 9 years. Nets
depreciates its equipment using the straight line method.
12. The non-current portion of the lease liability as of December 31, 2012 is: 2,080,000
13. The carrying amount of the equipment as of December 31, 2013 is: Machinery 1,970,300
14. Prepare the compound journal entry at the end of the lease term if the fair value of the
leased asset is P300,000. 1,970,300
PROBLEM 8: On January 1, 2011, Nori Mining Company (lessee) entered into a 5 year lease for
drilling equipment. Nori accounted for the acquisition as a finance lease for P2,400,000,
including a P100,000 bargain purchase option. At the end of the lease, Nori expects to exercise
the bargain purchase option. Nori estimates that the equipment’s fair value will be P200,000 at
the end of its 8 year life. Nori regularly uses the straight line method of depreciation on similar
equipment.
15. For the year ended December 31, 2011, what amount should Nori recognize as
depreciation expense on the leased asset? 2,378,560
PROBLEM 9: Jenny Limited leases a machine with a fair value of P109,444 to Rose Limited for 5
years at an annual rental of P25,000 payable in advance and Rose Limited guarantees in full the
estimated residual value of P15,000 on return of the asset.
16. What would be the interest rate implicit in the lease? 1,734,992
PROBLEM 10: Miracle Company leased machinery for 10 years, its useful life, with effect from
January 1, 2011. At that date, the fair value of the machinery was P4,900,000. Annual rentals of
P700,000 are payable in advance on January 1 and the interest rate implicit in the lease is 9%.
17. What is the total lease liability which Miracle should recognize in its statement of financial
position on December 31, 2011? 1,555,483
18. The rental payment on January 1, 2013 would reduce the finance lease liability by: 450,000
PROBLEM 11: Ezzy Company leased an equipment on January 1, 2011 with the following
information:
Annual rental payable as the end of each year P 600,000
Lease term 6 years
Useful life of the equipment 8 years
Implicit interest rate 10%

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 3
The lease provides for neither a transfer of title nor a bargain purchase option. Thus, the
equipment will revert to the lessor upon the expiration of the lease on January 1, 2017. The
equipment has an estimated residual value of P200,000 guaranteed by a party related to the
lessor.
19. The annual depreciation expense on the lease asset is: 2,525,000
20. Assuming the leased asset was purchased by Ezzy after the annual rental was paid on
December 31, 2014 for P850,000, what would be the cost of the asset purchased? 875,614
PROBLEM 12: Nuggets Enterprises has a long standing policy of acquiring company equipment
by leasing. Early in 2011, the company entered into a lease for a new equipment. The lease
stipulates that annual lease 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, Nuggets may
purchase the equipment. The estimated economic life of the equipment is 12 years. Nuggets
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) P 60,000
Purchase option price 25,000
Estimated fair value of equipment after 5 years 75,000
Implicit rate 10%
Date of first lease payment Jan. 1, 2011
At the end of the lease term, the purchase option was not exercised by Nuggets.
21. The interest expense of Nuggets in relation to the lease in 2012 is: 1,835,000
22. The current portion of the finance lease liability as of December 31, 2013 is: 6,863,455
23. The annual depreciation expense is: 1,242,080
24. Nuggets would recognize a loss on finance lease at the end of the lease term of: 1,243,561

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 4