Review Materials

Prepared by:
Junior Philippine Institute of
Accountants UC-Banilad Chapter
F.Y. 2019-2020
LEASES
Definitions

Lease – a contract, or part of a contract, that conveys

the right to use an asset (the underlying asset) for a
period of time in exchange for consideration

Parties to a lease contract:

▪ Lessee – the entity that obtains the right to use an
underlying asset for a period of time in exchange for
consideration
▪ Lessor – the entity that provides the right to use an
underlying asset for a period of time in exchange for
consideration
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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.
- a portion of an asset is an identified asset if it is
physically distinct. If not physically distinct, the portion is
not an identified asset,unless it represents substantially all
of the capacity of the asset thereby providing the customer
the right to obtain substantially all of the economic benefits
from the asset.
- an asset is not an identified asset if the supplier has the
substantive right to substitute it throughout the period of
use.
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Conditions before an asset can be substituted

a. The supplier has the practical ability to substitute

alternative asstes throughout the period of use
b. The supplier would benefit economically from the
exercise of its right to substitute the asset

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Identifying a lease

Is there an identified asset?

No
Yes

Does the customer have the right to

Contract is not
obtain substantially all of the economic
(does not
benefits form use of the identified asset
No contain) a
throughout the period of use?
lease.
Yes

Does the customer have the right to direct

the use of the identified asset throughout
the period of use?
No

Yes

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Contract is (contains) a lease.
Lease term

a. periods covered by an option to extend the lease if

the lessee is reasonably certainto exercise that
option; and
b. periods covered by an option to terminate the
lease if the lessee is reasonably certain not to
exercise that option.

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Lessee 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 as at the commencement date and subsequently
measured at amortized cost.
• The discount rate used is the interest rate implicit in the lease. If this is not
determinable, the lessee’s incremental borrowing rate is used.
• The right-of-use asset is initially measured at cost and subsequently measured
similar to a 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 to recognize lease payments as expense over the lease term using the
straight-line basis, or another more appropriate basis.

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On January 1, 20x1, Entity X enters into a 3-year lease of equipment for
an annual rent of P100,000 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 X uses the straight-line method if depreciation. The
relevant present value factors are as follows:
- PV of an ordinary annuity of P1 @10%, n=3………. 2.48685
- PV of an ordinary annuity of P1 @12%, n=3………. 2.40183
》Initial measurements of Lease liability and Right-of-use asset
Fixed payments 100,000
Multiply by: PV of an ordinary annuity of P1 @10%, n=3 2.48685
Lease liability 248,685
Right-of-use asset = 248,685
》Subsequent measurement
Cost 248,685
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Divide by: Lease term(shorter) 3
Annual depreciation 82,895
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.
• Indicators 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,
discontinues 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.
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Example for Finance Lease
On January 1, 20x1, Entity Y 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
Interest 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 factor is
as follows:
- PV of an ordinary annuity of P1 @10%, n=3………. 2.48685
Gross Investment = Lease payments + Unguaranteed residual value
= 300,000 + (---) = 300,000
Net Investment = Present value of Gross investment or (PV of lease
payments + PV of Unguaranteed residual value)
= 100,000(2.48685) = 248,685
11 Unearned Interest Income = Gross investment – Net investment
= 300,000 – 248,685 = 51,315
 End of Topic
Please see complementary test bank for
practice problems and theories.

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 Dear, you.
Always be in pursuit for
the one you have not yet
become. Keep going!
Love,
Your UCB-JPIA family

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Reference:
Millan, Z.V. (2018). Conceptual Framework & Accounting
Standards. Baguio City: Bandolin Enterprise

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