LEASES

LEASE PART 1
Illustrative 1: Pepper Company owns an office building and normally charges tenants P3,000
per square meter per year for office space.

Because the occupancy rate is low, Pepper Company agreed to lease 1,000 square meters to
Ivana Company at 1,200 per square meter for the first year of a three-year operating lease.
Rent for the remaining years will be at the P3,000 rate.

Pepper Company moved into the building on January 1, 2022 and paid the first year's rent in
advance.

Required: What amount of rental revenue should be reported in the income statement
for the year ended September 30, 2022?
a. 2,400,000
b. 1,200,000
c. 1,800,000
d. 900,000

Illustrative 2: Pepper Company leased an office to Ivana Company for a five-year term
beginning January 1, 2022.

Under the terms of the operating lease, rent for the first year is P800,000 and rent for years 2
through 5 is P1,250,000 per annum.

However, as an inducement to enter the lease, Pepper Company granted Ivana Company the
first six months of the lease rent-free.

Required: What amount should be reported as rental income for 2022?

a. 1,200,000
b. 1,160,000
c. 1,080,000
d. 800,000

Illustrative 3: On January 1, 2017, Pepper Company leased a building to Ivana Company

under a four-year operating lease. The monthly rental for 2017, 2018, 2019, and 2020 is
P100,000, P150,000, P200,000 and P 250,000, respectively. Rentals are payable at the end
of each month. All rental payments within the year were made when due.

Required: What amount should be reported as rent receivable from Ivana Company on
December 31, 2018?
a. 1,000,000
b. 600,000
c. 1,200,000
d. 900,000

Illustrative 4: On January 1, 2022, Pepper Company leased a building to Ivana Company

under an operating lease for ten years at P500,000 per year, payable the first day of each
lease year. Pepper Company paid P150,000 to a real estate broker as initial direct costs. the
building is depreciated P120,000 per year. Pepper Company insurance and property tax
expense totaling P90,000 for 2022.

Required: What is the net rent income for 2022?

a. 275,000
b. 290,000
c. 350,000
d. 365,000

Illustrative 5: Pepper Company leased a new machine to Ivana Company on January 1,

2022. The lease expires on January 1, 2027. The annual rental is P900,000. Additionally, on
January 1, 2022, Ivana Company paid P500,000 to Pepper Company as a lease bonus and
P250,000 as a security to be refunded upon expiration of the lease.

Required: What amount should be reported as rent revenue for the current year?
a. 1,400,000
b. 1,250,000
c. 1,000,000
d. 900,000

LEASE PART 2
Illustrative 6: On January 1, 2022, Pepper Company leased a machinery to Ivana Company
with the following details:

Cost of Machinery P 1,518,650

Lease Term 4 years
Useful life of the machinery 4 years
Implicit interest rate before initial direct cost 12%
Implicit interest rate after initial direct cost 10%
Present value of annuity of 1 for 4 years at 12% 3.0373
Present value of annuity of 1 for 4 years at 10% 3.1699

On January 1, 2022, Pepper Company paid initial direct cost of P 66,300.

Required:
1. How much is the Gross Investment?
2. How much is the Net Investment?
3. How much is the Unearned Interest Income?
4. How much is the carrying amount of the Lease Receivable on December 31, 2022?
5. How much is the current portion of the Lease Receivable on December 31, 2022?
6. How much is the noncurrent portion of the Lease Receivable on December 31, 2022?

Illustrative 7: On January 1, 2022, Pepper Company leased a machinery to Ivana Company

with the following details:

Cost of Machinery P3,760,100

Residual Value Guarantee 400,000
Useful life and lease term 4 years
Implicit interest rate 10%
PV of 1 at 10% for 4 periods 0.6830
PV of an annuity of 1 at 10% for 4 periods 3.1699
PV of an annuity due of 1 at 10% for 4 3.4869
periods

The annual rental is payable in advance on January of each year starting January 1, 2022.

Required:
1. How much is the annual rental?
2. How much is the Gross Investment?
3. How much is the Net Investment?
4. How much is the Unearned Interest Income?

Illustrative 8: On January 1, 2022, Pepper Company leased a machinery to another entity

with the following details:

Cost of Machinery P 3,449,600

Residual Value Guarantee 500,000
Useful life and lease term 5 years
Implicit interest rate 8%
PV of 1 at 8% for 5 periods 0.681
PV of an annuity of 1 at 8% for 5 periods 3.993
PV of an annuity due of 1 at 8% for 5 periods 4.312

The annual rental is payable in advance on January 1 of each year starting January 1, 2022.

The lease provides for a transfer of title to the lessee at the end of the lease term.

Required:
1. How much is the annual rental?
2. How much is the Gross Investment?
3. How much is the Net Investment?
4. How much is the Unearned Interest Income?
Illustrative 9: Pepper Company is a dealer in machinery. On January 1, 2022, a machinery
was leased to Ivana Company with the following provisions:

Annual rental payable at the end of each year P800,000

Lease term 5 years
Useful life of machinery 5 years
Cost of machinery 2,000,000
Estimated Residual Value 200,000
Initial Direct Cost paid by lessor 100,000
Implicit interest rate 10%
Present value of annuity of 1 for 5 years at 10% 3.7908
Present value of 1 for 5 periods at 10% 0.6209

At the end of the lease term on December 31, 2026, the machinery will revert to Pepper
Company.

Required:
Scenario A: Residual Value is Guaranteed
1. How much is the Gross Investment?
2. How much is the Net Investment?
3. How much is the Unearned Interest Income?
4. How much is the Sales?
5. How much is the Cost of Goods Sold?
6. How much is the gross profit?
7. How much is the carrying amount of the Lease Receivable on December 31, 2022?

Scenario B: Residual Value is Unguaranteed

1. How much is the Gross Investment?
2. How much is the Net Investment?
3. How much is the Unearned Interest Income?
4. How much is the Sales?
5. How much is the Cost of Goods Sold?
6. How much is the gross profit?
7. How much is the carrying amount of the Lease Receivable on December 31, 2022?

Illustrative 10: Pepper Company is a dealer in equipment. On January 1, 2022, an

equipment is leased to Ivana Company with the following provisions:

Annual rental payable at the end of each year P500,000

Lease term 4 years
Useful life of machinery 5 years
Cost of machinery 1,000,000
Purchase Option 200,000
Initial Direct Cost paid by lessor 100,000
Implicit interest rate 8%
Present value of annuity of 1 for 4 years at 8% 3.312
Present value of 1 for 4 periods at 8% 0.735

It is reasonably certain that the lessee will exercise the purchase option on December 31,
2025.

Required:
1. How much is the Gross Investment?
2. How much is the Net Investment?
3. How much is the Unearned Interest Income?
4. How much is the Sales?
5. How much is the Cost of Goods Sold?
6. How much is the gross profit?

Illustrative 11: Pepper Company sold an equipment that it had been leasing under a sales
type lease for 3,500,000.

The following balances are associated with the finance lease on the books of Pepper on the
date of the sale:
Lease Receivable P 5,000,000
Unearned Interest Income P 1,200,000

Required: How much is the gain or loss on the actual sale of the equipment?

LEASE - LESSEE'S POV

Illustrative 1: On January 1, 2022, Pepper Company leased a machinery for 4 years. The
useful life of the machinery is 5 years. The lease is at annual rental or fixed payment of P
100,000 payable at the end of each year. The implicit rate of interest is 12%. The lease
provides for a transfer of ownership of the underlying asset to the lessee at the end of the
lease term.

Required:
1. What is the initial lease liability?
2. What is the cost of the right of use asset?
3. How much is the depreciation expense for the year 2022?
4. How much is the carrying amount of the right of use asset at the end of 2022?
5. Prepare an amortization schedule.
Illustrative 2: Pepper Company leased an equipment on January 1, 2022 with the following
information:
Fixed Annual Payment at the end of each year P 1,000,000
Lease Term 4 years
Useful life of equipment 5 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 for 4 periods at 3.16987
10%
Present value of 1 for 4 periods at 10% 0.683

Pepper Company has guaranteed a P 200,000 residual value on December 31, 2025.

Required:
1. What is the initial lease liability?
2. What is the cost of the right of use asset?
3. How much is the depreciation expense for the year 2022?
4. How much is the carrying amount of the right of use asset at the end of 2022?
5. Prepare an amortization table.
6. How much is the loss on finance lease if the fair value of the equipment on December 31,
2025 is only P 150,000.
7. How much is the gain on finance lease if the fair value of the equipment on December 31,
2025 is P 250,000.

No Illustrative 3:

Illustrative 4: Pepper Company leased an equipment on January 1, 2022 with the following
information:
Fixed Annual Payment in advance at the beginning of each lease year P 1,000,000
Initial Direct Cost Paid on January 1, 2022 250,000
Lease Incentive Received 150,000
Residual Value Guarantee 300,000
Lease Term 5 years
Useful life of equipment 6 years
Implicit interest rate 8%
Present value of an annuity due of 1 for 5 periods at 8% 4.3121
Present value of 1 for 4 periods at 10% 0.6806
Required:
1. What is the initial lease liability?
2. What is the cost of the right of use asset?
3. How much is the depreciation expense for the year 2022?
4. How much is the interest expense for the year 2022?

Illustrative 5: Pepper Company Leased a Machine on January 1, 2022 with the following
pertinent information:

Fixed Annual Payment at the end of each year P 1,000,000

Lease Term 10 years
Useful life of equipment 12 years
Incremental borrowing rate 14%
Implicit interest rate 12%
Present value of an ordinary annuity of 1 for 10 periods at 14% 5.216
Present value of an ordinary annuity of 1 for 10 periods at 12% 5.650
Present value of 1 for 10 periods at 14% 0.270
Present value of 1 for 10 periods at 12% 0.322

Pepper Company has the option to purchase the machine upon the lease expiration on
January 1, 2022 by paying P 500,000.

The lessee is reasonably certain to exercise the purchase option at the commencement date
of the lease.

The estimated residual value of the machine at the end of the 12-year useful life is P 600,000.

Required:
1. What is the initial lease liability?
2. What is the cost of the right of use asset?

Illustrative 6: Pepper Company purchased an equipment that it had been leasing under a
finance lease for P 4,000,000.

The balances of certain accounts on the date of actual purchase are as follows:

Right of Use Asset. P 5,000,000

Accumulated Depreciation 1,500,000
Lease Liability. 3,800,000
What is the cost of the equipment purchased?

SALE AND LEASEBACK TRANSACTIONS

Illustrative 1: At the beginning of the current year, Pepper Company sold a machinery with a
remaining life of 10 years for P 2,000,000 which is equal to the fair value of the machinery.
Pepper Company immediately leased the machinery back for 1 year at the prevailing annual
rental of P 300,000.

The machinery has a cost of P 3,000,000 and an accumulated depreciation of P 1,200,000.

Required:
1. How much is the gain or loss on the sale that the seller - lessee must recognize?
2. How much is the rent expense that the seller - lessee must recognize?
3. How much is the rent income that the buyer - lessor must recognize?

Illustrative 2: An asset with carrying amount of P 5,000,000 was sold at its fair value of P
6,000,000. The seller immediately leased back the building from the buyer with annual rental
of P 750,000 for ten years with lease payment, payable at the end of each of the next ten
years. On this date, the market rate of interest is 10%.

Required: Determine the following on the books of Seller - Lessee.

1. Initial measurement of lease liability.

2. Cost of right of use asset.
3. Total gain.
4. Gain to be recognized.
5. Gain not to be recognized.

Illustrative 3: An asset with carrying amount of P 5,000,000 was sold at P 6,500,000. The fair
value of the asset on the date of sale is P 6,000,000. The seller immediately leased back the
building from the buyer with annual rental of P 750,000 for ten years with lease payment,
payable at the end of each of the next ten years. On this date, the market rate of interest is
10%.

Required: Determine the following on the books of Seller - Lessee

1. Initial measurement of lease liability.
2. Cost of right of use asset.
3. Total gain.
4. Gain to be recognized.
5. Gain not to be recognized.

Illustrative 4: An asset with carrying amount of P 5,000,000 was sold at P 5,500,000. The fair
value of the asset on the date of sale is P 6,000,000. The seller immediately leased back the
building from the buyer with annual rental of P 750,000 for ten years with lease payment,
payable at the end of each of the next ten years. On this date, the market rate of interest is
10%.

Required: Determine the following on the books of Seller - Lessee

1. Initial measurement of lease liability.
2. Cost of right of use asset.
3. Total gain.
4. Gain to be recognized.
5. Gain not to be recognized.

LEASE MODIFICATION AND VARIABLE LEASE PAYMENTS

Illustrative 1: On January 1, 2027, Pepper Company entered into an 8-year lease of a floor
of a building with the following terms:

Annual rental for the first two years payable at the end of each year P400,000
Annual rental for the next three years payable at the end of each year 500,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 2 periods 1.7355
PV of 1 at 10% for 2 periods 0.8264
PV of an ordinary annuity of 1 at 10% for 3 periods 2.4869

Required:
1. How much is the initial measurement of the lease liability?
2. Prepare an amortization table.

Illustrative 2: Pepper Company entered into a lease of building on January 1, 2027 with the
following information:

Annual rental payable at the end of each year P 500,000

Lease term 5 years
Useful life of the building 20 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 5 periods 3.791

The lease contained an option for the lessee to extend for a further 5 years. At the
commencement date, the exercise of the extension option is not reasonably certain.

After 3 years on January 1, 2030, the lessee decided to extend the lease for a further 5 years
with the following information:

New annual rental payable at the end of each year P 600,000

New implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for 5 periods 3.993
PV of 1 at 8% for 2 periods 0.857
PV of an ordinary annuity of 1 at 8% for 2 periods 1.783

Required:
1. How much is the initial measurement of the lease liability?
2. How much is the initial cost of right of use asset?
3. How much is the interest expense for the year ended December 31, 2027?
4. How much is the depreciation expense for the year ended December 31, 2027?
5. How much is the carrying amount of lease liability on December 31, 2029?
6. How much is the carrying amount of right of use asset on December 31, 2029?
7. How much is the adjusted balance of lease liability on January 1, 2030?
8. How much is the adjusted carrying amount of right of use asset on January 1, 2030?
9. How much is the depreciation expense for the year ended December 31, 2030?
10.How much is the carrying amount of lease liability on December 31, 2032?