Lease

December 1, 2021

Problem 1: Write the letter as well as the entire answer

1. The accounting concept that is principally used to classify leases into operating and finance lease
a. Substance over form
b. Prudence
c. Neutrality
d. Completeness
2. It is the date on which the lessee is entitled to exercise its right to use the leased assets
a. Inception of the lease
b. Commencement of the lease
c. Date of lease agreement
d. Date of commitment to the provision of the lease
3. Net investment is equal to the
a. Gross investment in the lease less unearned finance income
b. Cost of the lease asset
c. The minimum lease payments
d. The minimum lease payments less unguaranteed residual value
4. Which of the following situation would prima facie lead to a lease being classified as operating
lease?
a. Transfer of ownership to the lessee at the end of the lease term
b. Option to purchase at a value below the fair value of the asset
c. The lease term is for the major part of the asset’s life
d. The present value of the minimum lease payments is 75% of the fair value of the asset
5. In a lease that is recorded as a sales-type lease by the lessor, interest revenue
a. Does not arise
b. Should be recognized over the period of the lease using the interest method
c. Should be recognized over the period of the lease using the straight line method
d. Should be recognized in full as a revenue at the lease’s inception
6. What is the treatment of an unguaranteed residual value in determining the cost of sales under
a sales type lease?
a. The unguaranteed residual value is ignored
b. The unguaranteed residual value is added to the cost of the asset
c. The unguaranteed residual value is deducted from the cost of the leased asset at absolute
amount
d. The unguaranteed residual value is deducted from the cost of the leased asset at present
value
7. When an equipment held under an operating lease is subleased by the original lessee, the
original lessee would account for the sublease as
a. Operating lease
b. Sales-type lease
c. Direct financing lease
d. Finance lease
8. An entity sold its headquarters building at a gain, and simultaneously leased back the building.
The lease was reported as a finance lease. At the time of sales, the gain should be reported as
a. Operating income
 b. A direct credit to retained earnings
c. A separate component of stockholder’s equity
d. An asset valuation allowance
9. Under the direct financing method of accounting for leases, the excess of aggregate rentals over
the cost of the leased property should be recognized as revenue of the lessor
a. In increasing amounts during the term of the lease
b. In constant amount during the term of the lease
c. In decreasing amounts during the term of the lease
d. After the cost of leased property has been fully recovered through rentals
10. Beal Inc. Intends to lease a machine from Paul Corporation. Beal’s incremental borrowing rate is
14%. The prime rate of interest is 8%. Paul’s implicit rate in the lease is 10%, which is known to
Beal. Beal computes the present value of the minimum lease payments using
a. 8%
b. 10%
c. 12%
d. 14%

Problem 2

Sabotage Company leases and operates a retail store. The following information relates to the lease for
the year ended December 31, 2019.

 The store lease, an operating lease, calls for a base monthly rent of 1,500 on the first day of each
month. The lease term is for two years.
 Additional rent is computed equal to 7% of net sales over 200,000 up to 600,000 and 4% of net
sales over 600,000 per calendar year. The contingent rent is due on December 31. Net sales
were 865,000.
 On December 31, Sabotage paid executory costs to the lessor for property taxes of 12,000 and
insurance of 5,000
 On January 1, Sabotage made a rent security deposit of 25,000 and paid another 25,000 as a
bonus for the lease
 On January 1, before the inception of the lease, the lessor made a major overhaul for the
property costing 250,000

1. Journal entries for the month of January 2019 and December 2019 on the books of Sabotage
2. Compute for the total expenses related to the lease

Problem 3

On October 1, 2020, Magtibay Company leased office space at a monthly rental of 30,000 for ten years
expiring September 30, 2020. As an inducement for Magtibay to enter into lease, the lessor permitted
Magtibay to occupy the premises rent-free from October 1 to December 31, 2020. Improvements were
made at the leased office at a total cost of 300,000, the improvements were finished on October 31,
2020. It was estimated that the improvements will be useful for 5 years. For the year ended December
31, 2020, Magtibay should report total expense related to the lease facilities of
Problem 4

On January 1, 2021, Panday Old Co., acting as a lessor, leased a computer for ten years at an annual
rental of 120,000, payable by Aqua Betadine, Inc., the lessee, at the beginning of each year. The
computer had a cost and fair market value of 840,000 with an estimated life of 12 years with no residual
value. Panday Old uses the straight line depreciation. The implicit rate is 9%.

What amount of income should be reported in 2021 by Panday Old if the lease was accounted for as:
(1) Operating Lease (2) Direct Financing Lease

Problem 5

On January 1, 2021, Peter Pan Co. sold equipment with carrying amount of 1,000,000 and remaining
useful life of 12 years to Marco Drilling for 1,600,000, Peter Pan immediately leased the equipment back
under a 10 year finance lease payment of 244,120 in December 2021.

Journal entries for 2021 on the books of Peter Pan and Marco Drilling

Problem 6

The following information pertains to an operating sale and leaseback of equipment by Tremble
Company on December 1, 2020: Sales price, 420,000; Carrying amount, 360,000; Monthly lease
payment, 37,316; Fair Value 400,000; Estimated remaining life, 12 years; Lease term, 1 year; Implicit
rate, 12%.

Journal entries for the month of December 2020

Problem 7

On December 31, 2021, Rayver Corporation sold to Sarah Corporation an airplane with an estimated
remaining useful life of ten years. At the same time, Rayver leased back the airplane for three years.
Additional information is as follows:
Sales price 600,000
Carrying amount of airplane at the date of sale 100,000
Monthly rental under lease 6,330
Interest rate implicit to the lease as computed by Sarah and known by
Reyver (this rate is lower than the lessee’s incremental borrowing rate 12%
Present value of operating lease rentals (6,330 for 36 months at 12%) 190,581

What amount should be included as (1) deferred revenue (2) outright gain on this transaction?

Problem 8

On April 1, 2019, Hey Der Company leased a machine with the following provisions:

 Annual rental of 800,000 payable annually starting April 1, 2020

 Lease Term 4 years
  Useful term of the machine 6 years
 Implicit annual interest rate 8%
 Bargain purchase option which is sufficiently lower than
the expected fair value of the machine at the end of 4 years 150,000
 Initial direct cost paid by lessee 40,000
 PV of ordinary annuity of 1 at 8% for 4 periods 3.3121
 PV of 1 at 8% for 4 periods 0.7350

REQUIRED:
1. Prepare a schedule of amortization
2. Prepare entries in the books of the lessee from April 1, 2019 to December 31, 2021. The
accounting period ends on December 31.
3. Prepare the entry on April 1, 2023 to record the exercise of the bargain purchase option.
4. Assuming the bargain purchase option is not exercise, what is the entry?

Problem 9

On December 31, 2020, Kuya Kim Company signs a 10-year non-cancellable lease agreement to lease a
storage building from Storage Company. The following information pertains to this lease agreement:

1. The agreement requires equal rental payments of 720,000 beginning December 31, 2020.
2. The building has an estimated economic life of 12 years, with an unguaranteed residual value of
100,000. Kuya Kim depreciates similar building on the straight line method.
3. The lease is non-renewable. At the termination of the lease the building will revert to the lessor.
4. Kuya Kim incremental borrowing rate is 12% per year. The lessor’s implicit rate is not known to
Kuya Kim.
5. The yearly rental payment includes 24,705 of executory costs related to taxes on the property.

The following present value factors are for 10 periods at 12% annual interest rate:
Present value of an annuity due of 1 6.32825
Present value of ordinary annuity of 1 5.65022
Present value of 1 0.32197

1. What amount should be capitalized as the cost of the leased storage building?
2. What amount should be included in the current liabilities section of Kuya Kim’s balance sheet at
December 31, 2021?
3. What amount should be included in the non-current liabilities section of Kuya Kim’s balance
sheet at December 31, 2021?
4. What are the total lease-related expenses to be reported on Kuya Kim’s income statement for
the year ended December 31, 2021?

Problem 10

On January 1, 2019, Valix Company leased equipment to another company with the following
information:

Cost of machinery 2,500,000

 Lease term 3 years
Useful life of equipment 3 years
Implicit interest rate 12%
Incremental borrowing rate of the lessor 15%
Present value of annuity of one for 3 years at 12% 2.4018
Present value of annuity of one for 3 years at 15% 2.2832

REQUIRED:
1. Annual rental assuming that the payments are made at the end of the year
2. Prepare a schedule of amortization
3. Journalize the above transaction

Problem 11

Kaya Pa! Company is a dealer in machinery. On January 1, 2020, machinery was leased to No Match
Company with the following provisions:

Annual rental payable at the end of each year 1,000,000

Lease term 5 years
Useful life of machinery 5 years
Cost of Machinery 3,300,000
Estimated residual value 300,000
Initial direct cost paid by the lessee 100,000
Initial direct cost paid by the lessor 115,000
Executory costs 73,000
Implicit interest rate 10%
Incremental borrowing rate by the lessee 9%
Present value of an ordinary annuity of 1 for 5 periods at 10% 3.7908
Present value of 1 for 5 periods at 10% 0.6209
Present value of an ordinary annuity of 1 for 5 periods at 9% 3.8897
Present value of 1 for 5 periods at 9% 0.9174

At the end of the lease term, the machinery will revert to the lessor. The perpetual inventory system is
used.
REQUIRED:
1. Journal entries on the books of Kaya Pa! for 2020 assuming the residual value is guaranteed by
the lessee (Show your computation)
2. Journal entries on the books of Kaya Pa! for 2020 assuming the residual value is unguaranteed
by the lessee (Show your computation)
Assume on December 31, 2025, end of the lease term the fair value of the asset is:
a. 300,000
b. 320,000
c. 280,000
3. Prepare the entries on December 31, 2025 under each of the three assumptions assuming the
residual value is guaranteed by the lessee
4. Prepare the entries on December 31, 2025 under each of the three assumptions assuming the
residual value is unguaranteed by the lessee