Professional Documents
Culture Documents
CSC 201-Leones, Mary Grace O. - Intermediate
CSC 201-Leones, Mary Grace O. - Intermediate
CSC 201-Leones, Mary Grace O. - Intermediate
The main distinction between the two is the presence or absence of a manufacturer or dealer profit or loss.
A sales type lease recognizes interest income and gross profit on sale.
No dealer profit is recognized because the fair value and the cost of the asset are equal.
Accounting Considerations
a. Gross Investment -This is equal to the gross rentals for the entire lease term plus the absolute
amount of the residual value, whether guaranteed or unguaranteed.
b. Net Investment in the Lease -This is equal to the cost of the asset plus any initial direct cost paid
by the lessor.
c. Unearned Interest Income -This is the difference between the gross investment and net investment
in the lease
d. Initial Direct Cost -In a direct financing lease, the initial direct cost paid by the lessor is added to the
cost of the asset to get the net investment in the lease.
The initial direct cost would effectively spread the initial direct cost over the lease term and reduce
the amount of interest income.
Illustration - Direct financing lease
On January 1, 2020, Lessor Company leased a machinery to another entity with the following details:
The initial problem is the determination of the annual rental which will give the lessor a fair rate of return on
the net investment in the lease.
The procedure is to divide the "net investment in the lease to be recovered from rental” by present value
factor of an annuity of 1 for a number of periods using a desired rate of return, to get the annual rental.
Computation
The annual rental is computed by dividing the amount of Pl,518,650 by the present value factor, 3.0373, of
an annuity of 1 for 4 years at 12%, or P500.000.
Cash 500,000
Lease receivable 500,000
Table of amortization
The unearned interest income of P481.350 is recognized over the lease term following the effective interest
method.
Date Payment Interest Principal Present Value
Jan. 1,2020
Dec. 31,2020 500,000 182,138 317,762 1,518,650
Dec. 31,2021 500,000 144,107 355,893 1,200,888
Dec. 31,2022 500,000 101,399 398,601 844,995
Interest is equal to the preceding present value times the interest rate. Thus, for 2020, Pl,518,650 times
12% equals P 182,238.
Principal is the portion of the rental payment after deducting the interest. Thus,for 2020, P500.000 minus
P182,238 equals P317,762.
Present Value is the balance of the present value after deducting the principal payment.
Thus, on December 31, 2020, Pl,518,650 minus P317,762 equals Pl,200,888.
IFRS 16, paragraph 75, states that the lessor shall recognize finance income over the lease term based on
a pattern reflecting a constant periodic rate of return on the lessor’s
Net investment in the lease.
2020
Dec. 31 Unearned Interest Income 182,238
Interest Income 182,238
2021
Dec. 31 Unearned Interest Income 144,107
Interest Income
144,107
On January 1, 2020, Lessor Company leased a machinery to another entity with the following details:
Cost of machinery
Annual rental payable at the end of each year. 500,000
Lease term ‘ 4 years
Useful life of machinery 4 years
Implicit interest rate , 12%
Present value of annuity of 1 for 4 years a 12%. 3.0373
The initial direct cost is added to the cost of the machinery to determine the net investment in the lease.
The inclusion of the initial direct cost in the net investment in lease will have the effect of spreading the
initial direct cost over the lease term and reduce the interest income from the finance lease.
Gross rentals
2,000,000
Net investment in the lease
1,584,950
Consequently, the initial direct cost would decrease implicit interest rate in the lease.
The problem therefore is the determination of the reduced implicit interest rate.
The original implicit interest rate of 12% cannot be applied anymore because of the added initial direct cost.
The new implicit rate is computed by trial and error or through the interpolation process.
The new interest rate is definitely lower than 12% and it could be 11%, 10% or 9%.
The procedure is determine the present value of gross rentals that would equate the net investment in the
lease of Pl,584,950 using a particular rate.
Using 11%, the present value of an ordinary of 1 at 11% for 4 ,periods is 3.1024.
Thus, the present value of gross rentals is equal to P500,000 multiplied by 3.1024 or Pl,551,200.
This amount is not the same as the net investment in the lease. The new interest rate is not 11%.
Using 10%, the present value of an ordinary annuity of 1 at 10% for 4 periods is 3.1699.
Thus, the present value of gross rentals is equal to P500,000 multiplied by 3.1699 or Pl,584,950.
Coincidentally, this amount is the same as the net investment in the lease.
Accordingly, the reduced interest rate of 10% is used iff determining the annual interest income.
Journal entries
Cash 500,000
Lease receivable
500,000
The unearned interest income of P415.050 is recognized as income over the lease term following the
effective interest method of amortization.
Table of amortization
Jan. 1,2020
Dec. 31,2020 500,000 158,495 341,505 1,584,950
Dec. 31,2021 500,000 124,344 375,656 1,243,445
Dec. 31,2022 500,000 86,779 413,221 867,789
Dec. 31,2020 500,000 53,606 446,394 -
Interest is equal to the preceding present value times the interest rate.
Principal is the portion of the rental payment after deducting the interest.
Present value is the balance of the preceding value after deducting the principal payment.
Thus, on December 31, 2020, Pl,584,950 minus P341.505 equals Pl,243,445.
Journal entries
The recognition of interest income-for the first two years is’ recorded as:
2020
Dec.31 Unearned Interest Income 158,495
Interest Income 158,495
2021
Dec.31 Unearned Interest Income 124,344
Interest Income 124,344
If a statement of financial position is prepared by the lessor on December 31, 2020, the lease receivable of
Pl,500,00V would be reported as partly current and partly noncurrent.
Current portion
Noncurrent portion
IFRS 16, paragraph 67, states that lessors shall recognize assets held under a finance lease as a
receivable at an amount equal to the net investment in the lease.
Note that the unearned interest income which is realizable within one year from December 31, 2020 is
deducted from the current lease receivable.
On January 1, 2020, Lessor Company leased a machinery to another entity with the following details:
Cost of machinery
3,194,410
Residual value
500,000
Useful life and lease term 4
years
Implicit interest rate
10%
The machinery will revert to the lessor at the end of the lease, term because there is neither a transfer of
title nor a purchase option.
The problem is the determination of the annual rental. The annual rental is payable at the end of each year
with the first payment on December 31, 2020. The relevant present value factors are:
Cost of machinery
3,194,410
Present value of residual value (500,000 x .683)
( 341,500)
Annual rental
900,000
Note that the present value of the residual value is deducted from the cost of the asset if the machinery will
revert to the lessor at the end of the lease term.
Otherwise, if the machinery will not revert to the lessor at the end of the lease term, the residual value is
completely ignored.
Table of amortization
Interest is equal to the preceding present value times the interest rate. Thus, for 2020, P3,194,410 x 10%
equals P319.441.
Present value equals the balance of the present value minus the principal payment.
Cash 900,000
‘ Lease receivable
900,000
When the lease expires on December 31, 2023, the machinery will revert to the lessor.
Whether “guaranteed” or unguaranteed”, the entry on the books of the lessor will be the same.
Machinery 500,000
Lease receivable
500,000
Accounting problem
The accounting problem is when the fair value of the machinery is P400.000 which is lower than the
residual value ofP500,000.
Under the guaranteed scenario, the lessee will pay for the difference. The journal entry of the lessor is:
Cash 100,000
Machinery 400,000
Lease receivable. 500,000
Under the unguaranteed scenario, the lessor shall recognize a loss for the difference.
On January 1, 2020, Lessor Company leased a machinery to another entity with the following details:
Cost of machinery 3,760,000
Residual value guarantee 400,000
Useful life and lease term 4
years
Implicit interest rate
10%
The annual rental is payable in advance on January 1 of each year starting January I, 2020.
Since the residual value is guaranteed, the machinery will revert to the lessor at the end of the lease term.
Cost of machinery
3,760,100
Present value of residual value (400,000 x .683)
( 273,200)
Net investment to be recovered from rental .
3,486,900
Divide by PV of annuity of 1 in advance
at 10% for 4 periods
3.4869
Annual rental
1,000,000
Note that the rental is payable in advance at the beginning of each year. Thus, the “annuity of 1 in advance
factor” is used in the computation.
1/1/2020 3,760,100
1/1/2020 1,000,000 - 1,000,000 2,760,100
1/1/2021 1,000,000 276,010 723,990 2,036,110
1/1/2022 1,000,000 203,611 796,389 1,239,721
1/1/2023 1,000,000 123,972 876,028 363,693
1/1/2024 400,000 36,307 363,693 -
Interest is equal to the preceding present value times the interest rate. The first rental payment on January
1, 2020 pertains to principal only.
Thus, on January 1, 2021, the interest is equal to P2.760.100 times 10% or P276,010. This interest income
pertains to 2020.
Principal is the portion of the rental payment minus the interest. Thus, on January 1,2021, Pl,000,000
minus P276.010 equals P723,990.
Present value is the balance of the present value minus the principal payment.
Journal Entries
2020
Jan. 1 Lease Receivable 4,400,000
Machinery
3,760,000
Unearned Interest Income .
639,900
1 Cash 1,000,000
Lease Receivable
1,000,000
2021
Jan. 1. Cash 1,000,000
Lease Receivable
1,000,000
2022
Jan. 1. Cash 1,000,000
Lease Receivable
1,000,000
2023
Jan. 1. Cash 1,000,000
Lease Receivable
1,000,000
2024
Jan.1 On this date, the fair value of the machinery is P300,000 only. Since the guaranteed residual
value is P400,000, the lessor will pay for the difference of P100,000.
Cash 100,000
Machinery 300,000
Lease Receivable
400,000
On January 1, 2020, Lessor Company leased a machinery to another entity with the following details:
The lease provides for a transfer of title to the lessee at the end of the lease terms.
The present value of an annuity of 1 in advance at 8% for 5 periods is 4.312.
Annual rental
800,000
Note well that if the machinery will not revert to the lessor at the end of the lease term because the lease
provides for a transfer of title to the lessee, the*residual value is completely ignored in the computation of
the annual rental and the unearned interest income.
Thus, the annuity of 1 in advance or annuity due factor is used in the computation.
Table of amortization
1/1/2020 3,449,600
1/1/2020 800,000 - 800,000 2,649,600
1/1/2021 800,000 211,968 588,032 2,061,568
1/1/2022 800,000 164,925 635,075 1,426,493
1/1/2023 800,000 114,119 685,881 740,612
1/1/2024 800,000 59,388 740,612 -
Interest is equal to the preceding present value times the interest rate. The first rental payment on January
1, 2020 pertains to principal only.
Thus, on January 1, 2021 the interest is equal to P2,649,600 times 8% or P211,968. This interest income
pertains to 2020.
Principal is the portion of the rental payment minus the interest. Thus, on January 1, 2021, P800,000 minus
P211,968 equals P588,032.
Present value is the balance of the present value minus the principal payment. Thus, on January 1, 2021,
P2,649,600 minus P588,032 equals P2,061,,568.
2020
Jan. 1 Lease Receivable . 4,000,000
Machinery
3,499,600
1 Cash 800,000
Lease Receivable . 800,000
2021
Jan. 1 Cash 800,000
Lease Receivable . 800,000
QUESTIONS
1.What are the two classifications of finance lease on the part of the lessor?
a. Gross investment
b. Net Investment
c. Unearned interest income
5.What is the treatment of initial direct cost paid by the lessor in a direct financing lease?
7.Explain why the residual value is ignored in the computation of annual rental if the underlying asset will
not revert to the lessor at the end of lease term.
9.Explain the “trial and error” or interpolation approach of determining the implicit interest rate if an initial
direct cost is paid by the lessor in a direct financing lease.
10.Explain the presentation of the lease receivable in the statement of financial position.
PROBLEMS
At the beginning of current year, the an equipment was delivered to a lessee under a direct financing lease
with the following provisions:
The entity incurred and paid initial direct costs of P143.400 in negotiating and arranging the lease.
The equipment will revert to Iceberg Company at the end of “the lease.
Required:
1.Compute the total financial revenue to be recognized over the lease term.
2.Determine the new implicit rate that will be used in computing interest income.
3.Prepare journal entries on the books, of Iceberg Company for the current year.
At the end of the lease term, the equipment will revert to Jolo Company.
Required:
2.Prepare a table of amortization for the lease receivable and interest income.
5.Prepare journal entry on January 1, 2028 to record the return of the equipment from the lessee.
Macedonia Company entered into a leasing business. The entity acquired a specialized machine for
P3,000,000 cash.
On January 1,2020 the entity leased the machine to another entity for period of 6 years, after which the
machine is returned to Macedonia Company for disposition.
The lease terms are arranged so that a return of 12%’is earned by Macedonia Company.
The first lease payment is made on January 1, 2020 and subsequent payments are made each December
31. The relevant present value factors are:
Required:
1. Compute the annual rental payable in advance required to yield the desired return.
5.Prepare journal entry on December 31,2025, end of six years, to record the return of machine to the
lessor.
The fair value of the machine on this date is the same as the unguaranteed residual value.
The cost of the equipment to Alpha Company was Pl,377,480 which approximates the fair value on the
lease date. The expected economic life of the equipment is also 4 years.
The lease payments stipulated in the lease are P440,000 per year in advance for a 4-year period of the
lease. The payments include P40,000 executory costs per year.
The title to the equipment remains in the hands of Alpha Company at the end of the lease term, although
only nominal residual value is expected at that time.
The implicit interest rate in the lease is 11%. The fiscal year of Alpha Company ends December 31.
Required:
2.Prepare an amortization schedule for the lease receivable and interest income.
3.Prepare journal entries for 2020, 2021, 2022 and 2023.
Desiree Company is in the business of leasing new sophisticated new equipment. The lessor expects a
12% return on net investment.
At the end of the lease term, the equipment u)ill revert to the lessor.
At the beginning of current year, an equipment is leased to a lessee with the following information:
a. 7,200,000
b. 7800,000
c. 5,000,000
d. 5,250,000
a. 5,000,000
b. 5,250,000
c. 4,400,000
d. 4,,650,000
a. 2,550,000
b. 1,950,000
c. 3,150,000
d. 1,500,000
e.
4 What is the interest income for the current year?
a. 594,000
b. 522,000
c. 630,000
d. 450,000
Oceanic Company is engaged in leasing equipment. Such an equipment was delivered to a lessee at the
beginning of current year under a direct financing lease with the following provisions:
Cost of equipment
4,361,200
Residual value – unguaranteed 200,000
Useful life and lease term 8
years
Implicit interest rate
10%
Present value of an ordinary annuity
5.355
Present value of 1 for 8 years at 10%
0.466
The annual rental is payable at the end of each year. The equipment will revert to the lessor upon the lease
expiration.
a. 4,361,200
b. 4,161,200
c. 4,268,000
d. 4,561,200
3.What amount of interest income should be recognized for the current year?
a. 436,120
b. 416,120
c. 426,800
d. 640,000
At the beginning of current year, Lessor Company leased a machine to Lessee Company. The machine
had an original cost of P66,000,000. The lease term was five years and the implicit Interest rate on the
lease was 15%.
The lease is properly classified as a direct financing lease. The annual lease payments of P1,750,000 are
made each December 31.
The machine reverts to Lessor at the end of the lease term, at which time the residual value P275,000. The
residual value is unguaranteed.
1.At the commencement of the lease, What would be the net lease receivable on the part of the lessor?
a. 6,275,000
b. 8,750,000
c. 6,000,000
d. 5,725,000
a. 8,750,000
b. 9,025,000
c. 6,000,000
d. 8,475,000
a. 3,025,000
b. 2,750,000
c. 2,475,000
d. 6,000,000
On January 1,2020, Lyle Company entered into a direct financing lease. A third party guaranteed the
residual value of the asset under the lease estimated to be P1,200,000 on January 1, 2025, the end of the
lease term.
Annual lease payments are P1,000,000 due each December 31, beginning December 31,2020. The last
payment is due December 31,2024.
The remaining useful life of the asset was six years at the commencement of the lease.
The lessor used 10% as the implicit interest rate. The PV is 1 at 10% for 5 periods is 3.79
1.What is the net lease receivable of the lessor at the commencement of the lease?
a. 4,534,000
b. 3,790,000
c. 4,990,000
d. 2,590,000
a. 5,000,000
b. 6,200,000
c. 3,800,000
d. 5,744,000
a. 2,410,000
b. 1,666,000
c. 1,210,000
d. 466,000
a. 379,000
b. 620,000
c. 453,400
d. 500,000
Glade Company leases a computer equipment under a direct financing lease. The equipment has no
residual value at the end of the lease and the lease does not contain purchase option.
The entity wishes to earn 8% Interest on a 5-year lease of equipment with a coat of P3,234,000.
What total amount of interest revenue should be recognized over the lease term?
a. 1,293,600
b. 1,394,500
c. 516,000
d. 750,000
At the beginning of current year, Nueva Company, as lessor, leased an equipment for ten years at an annui
rental of P1,200,000,payable by Caster Company, the lessee, at the beginning of each year. The lease is
appropriately accounted for as finance lease.
The equipment had a cost of P8,400,000 with an estimated life of 12 years and no residual value. The
straight line depreciation is used. The implicit Interest rate is 9%
What amount of interest income should be reported in the income statement for the current year?
a. 500,000
b. 648,000
c. 756,000
d. 360,000
Cassandra Company is in the leasing business. The entity acquired a specialized packaging machine for
P3,000,000 cash and leased it for a period of six years, after which the machine is to be returned to
Cassandra Company for disposition. The guaranteed residual value is the machine is. P200,000.
The lease term was arranged so that a return of 12% is earned by Cassandra Company. The PV of 1 at
12% for six periods is .51, and the present value of an annuity of 1 in advance at 12% for six periods is
4.60
What is the annual lease payment payable in advance required to yield the desired return?
a. 630,000
b. 652,174
c. 608,695
d. 732,000
Magnum Company had an asset costing P5,239,000. The asset was leased at the beginning of the current
year to another entity. Five annual lease payments are due in advance at the beginning of each lease year.
The lessee guaranteed the P2,000,000 residual value of the asset at the end of the 5-years lease term.
The lessor’s implicit interest rate is 8%. The PV of 1 at 8% for 5 periods is . 68, and the PV of an annuity of
1 in advance at 8% for 5 periods is 4.31
a. 1,215,545
b. 1,531,090
c. 900,000
d. 751,500
Ericson Company leased an asset to another entity. The cost of the asset was P7,994,000. Terms of the
lease specify four-year life for the lease, an annual interest rate of 15%, and four year-end rental payments.
The lease qualified as a direct financing lease.
The lease provided for a transfer of title to the lessee at the end of the lease term.
After the fourth year, the residual value was estimated at Pl,000,000.
The PV of 1 at 15% for 4 periods is .572, and the PV of an ordinary annuity of 1 at 15% for 4 periods is
2.855.
What is the annual rental payment?
a. 2,000,000
b. 3,000,350
c. 2,800,000
d. 2,599,650
Irene Company acquired a specialized machine for P2,300,000. At the beginning of current year, the entity
leased the machine for a period of six years, after which title to the machine is transferred to the lessee.
The six annual lease payments are due in advance at the beginning of each lease year. The residual value
of the machine is P200.000.
The lease terms are arranged so that a return of 12% is earned by the lessor. The present value of 1 at
12% for six periods is 0.51, and the present value of an annuity in advance of 1 at 12% for six periods is
4.60.
a. 500,000
b. 477,826
c. 383,333
d. 460,000
At the beginning of current year, Yolk Company signed a ten-year non cancellable lease agreement to
lease a storage building from Warehouse Company. The agreement required equal rental payments at the
end of each year.
The fair value of the building at the inception of the lease is P2,949,600. However, the carrying amount to
Warehouse Company is P2,458,000. The building has an estimated economic life of 10 years with no
residual value.
At the termination of the lease, the title to the building will be transferred to Yolk Company. The incremental
borrowing rate of Yolk Company is 12% per year.
Warehouse Company set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is
known by the lessee.
The annual total lease payment included P20,000 of executory costs related to taxes on the property.
Round off present value factor to three decimal places.
1.What is the annual lease payment?
a. 400,000
b. 435,044
c. 480,000
d. 522,053
a. 420,000
b. 455,044
c. 542,053
d. 500,000
3.What is the unearned interest income of the lessor at the beginning of current year?
a. 1,850,400
b. 2,342,000
c. 1,542,000
d. 2,542,000
a. Sum of the lease payments receivable by a lessor under a finance lease and any unguaranteed
residual value accruing to the lessor.
b. The lease payments under a finance lease of the lessor.
c. Present value of lease payments under a finance lease of the lessor and any unguaranteed
residual value.
d. Present value of the lease payments under a finance lease of the lessor.
3.Which is the correct accounting treatment for a finance ‘ lease in the accounts of a lessor?
a. Treat as a noncurrent asset equal to net investment in lease and recognize all finance payments in
income statement.
b. Treat as receivable equal to gross amount receivable – on lease and recognize finance payments
in cash by reducing debt.
c. Treat as a receivable equal to net investment in the lease and recognize finance payments by
reducing debt and taking interest to income statement.
d. Treat as a receivable equal to net investment in the lease and recognize finance payments in cash,
by reduction of debt.
4.Lessors shall recognize asset held under a finance lease as a receivable at an amount equal to the
6.The primary difference between a direct financing lease and a sales type lease is the
8.Under a direct financing lease, the excess of aggregate rentals over the cost of the underlying asset
should be recognized as interest income of the lessor
a. Should be amortized over the lease term using the interest method.
b. Should be amortized over the lease term using the straight line method.
c. Does not arise.
d. Should be recognized at the lease expiration.
10.Which statement is true regarding initial direct costs incurred by the lessor?
a. In a direct financing lease, initial direct costs are added to the net investment in the lease.
b. In a sales type lease, initial direct costs are expensed as component of cost of goods sold.
c. In an operating lease, initial direct costs incurred by the lessor are deferred and allocated over the
lease term.
d. All of these statements are correct.