Finance Lease

Transfer of title
Option to purchase below market or bargain purchase option (BPO)
Lease term is major part of useful life
PV of lease payment is substantial of fair value
Special in nature
Finance Lease - Lessee Point of View
By substance the lessee purchased the leased asset on installment basis;
Lessee will recognize the leased asset as “right-of-use” asset;
Lessee will recognize lease liability amounting the to the PV of future payments
Lessee will incur interest expense based on the unpaid lease liability; and
Lessee will recognize periodic depreciation of the “right-of-use” asset.
What is the initial measurement of lease liability?
Present value of periodic payment X
Present value of bargain purchase option (BPO) or guaranteed residual value GRV X
Initial measurement of lease liability X
In getting the periodic payment, exclude:
a. Executory cost (maintenance cost, real property tax)
b. Contingent rent
What is the initial measurement of “right-of-use”?
Initial measurement of the liability X
Payment to lessor less any lease incentives received X
Present value of estimated dismantling cost X
Initial direct cost incurred by lessee X
Initial measurement of “right-of-use” X
What is the interest expense incurred?
Carrying amount at the beginning of the year X
Implicit rate x%
Interest expense X

What is the subsequent measurement of lease liability?

Initial measurement of lease liability X
Periodic payments net of interest expense (at implicit rate) (X)
Carrying amount at year-end? X
Computation of depreciation:
Initial measurement of “right-of-use” X
Residual value (X)
Depreciable cost X
Lease term or Useful life ÷X
Depreciation expense X
 Depreciate over the useful life, only if:
Transfer of title
Option to purchase at the end of lease term is certain to exercise
What is the subsequent measurement of “right-of-use”?
Initial measurement of “right-of-use” X
Accumulated depreciation (depreciation expense x age) (X)
Carrying amount of “right-of-use” at year-end X
Problem
On January 1, 2022, Godly Company entered into 5-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 200,000
Annual rental for the next three years payable at the end of each year 300,000
Initial direct cost paid by lessee 100,000
Estimated cost of restoration required by contract 50,000
Useful life of building 20 years
Implicit interest rate 8%
1. What is the initial lease liability?
2. What is the cost of the right of use asset?
3. What is the depreciation for 2022?
4. What is the interest expense?

Finance Lease – Lessor’s Point of View

Direct Financing
The lessor sold the lease asset on installment basis
The periodic payment is considered installment payment
No gross profit nor gain or loss on sale
How much is the gross investment?
Total periodic payment (periodic rent x lease term) X
Guaranteed (GRV) or unguaranteed (URV) residual value X
Gross investment X
In getting the periodic rent, exclude:
a. Executory cost
b. Contingent rent
GRV or URV should be ignored if there will be transfer of title
How much is the net investment?
Present value of periodic payments (period rent x PVF annuity) X
Present value of GRV or URV (GRV or URV x PVF) X
Net investment X
How much is the net investment? Alternative formula
Cost of the lease asset X
Initial direct cost X
Net investment X
Under direct financing:
Cost + IDC = PV of period + PV of GRV/URV
What is the unearned interest income? (total interest over the
lease term)
Gross investment X
Net investment X
Unearned interest (total interest over the lease term) X
How much is the interest income?
CA of lease receivable (net investment) at beginning of the period X
Implicit rate X%
Interest income X
What is the carrying amount of the lease receivable at year-end?
Net investment (initial carrying amount) X
Periodic payment less interest income (X)
Carrying amount of lease receivable, end X
Under direct finance lease, no recognition on the following:
Sale
Cost of sale
Gain or loss on sale
Sales type Lease
Lessor (dealer) is selling its inventory on installment basis
Cost + IDC ≠ PV of periodic rent + PV of GRV/URV
Lessor will recognize:
• Sales
• Cost of sales
• Gross profit (dealer’s profit)
How to compute the amount of cost of sales?
Cost X
Initial direct cost X
Present value of URV (URV x PVF) (X)
Cost of goods sold X
What is the gross profit of the company?
Sales (PV of periodic payment + PV of GRV) X
Cost of goods sold (Cost + IDC – PV of URV) X
Gross profit X
Use the following information for the next five (5) questions:
Alarcio Company is a dealer in equipment. On January 1, 2020, an equipment was leased to
another entity with the following provisions:
Annual rental payable at the end of each year 1,500,000
Lease term and useful life of machinery 5 years
Cost of equipment 4,000,000
Guaranteed residual value 500,000
Implicit rate 12%

At the end of the lease term on December 31, 2024, the equipment will revert to the lessor. On
such date, the fair value of the asset is P350,000. The perpetual inventory system is used. The
lessor incurred initial direct cost of P200,000 in finalizing the lease agreement.
PV of an ordinary annuity of 1 for 5 periods at 12% is 3.60, PV of 1 for 5 periods at 12% 0.57
(Present value factor round to two decimal places)

1) What is the gross investment in the lease?

A. 7,500,000 B. 8,000,000 C. 4,000,000 D. 4,500,000
2) What is the net investment in the lease?
A. 5,400,000 B. 5,685,000 C. 4,000,000 D. 3,500,000
3) What is the total financial revenue?
A. 2,315,000 B. 1,815,000 C. 2,100,000 D. 2,600,000
4) What is the interest income to be recognized for 2020?
A. 682,200 B. 648,000 C. 900,000 D. 960,000
5) What amount should be reported as profit on sale for 2020?
A. 1,485,000 B. 1,685,000 C. 3,500,000 D. 4,000
SALE AND LEASEBACK
Generally: No gain / loss
Gain : Carrying amount < Selling Price
Deferred and amortized
Loss: Carrying amount > Selling Price
Impairment
Selling Price is based on Fair Value
Gain: Fair Value > Carrying Amount
Selling Price ≤ Fair Value
Loss: Fair Value < Carrying amount
Selling Price = Fair Value
Selling Price is not based on Fair Value
Selling Price > Fair Value
Difference between selling price and fair value –
deferred and amortized over expected period of use
Difference between fair value and carrying amount –
recognized immediately