Intermediate Accoun ng 2

ACCOUNTING FOR LEASE BY LESSOR

A. OPERATING LEASE
Opera ng Lease- a lease that does not transfer substan ally all the risks and rewards incidental to
ownership of an underlying asset

1. At the beginning of current year, Arizona Company purchased a machinery for P 4,500,000 cash for the
purpose of leasing it. The machine is expected to have a 10 year life and no residual value.

Machinery 4,500,000
Cash 4,500,000
2. On May 1, Arizona Company leased the machine to another en ty for 3 years at a monthly rental of
80,000 payable at the beginning of every month.
Cash (80,000 x 8 months) 640,000
Rent Income 640,000
3. On May 1, Arizona Company received a security deposit of P300,000 to be refunded upon the lease
expira on.
Cash 300,000
Liability for rent deposit 300,000
4. In addi on to the rental, Arizona Company received from the lessee a lease bonus of P150,000 on
January 1.
Cash 150,000
Unearned rent income 150,000
5. On May 1, Arizona Company paid ini al direct cost of P270,000. Such costs are directly a ributable to
nego a ng and arranging the opera ng lease.
Deferred ini al direct cost 270,000
Cash 270,000
6. During the current year, Arizona Company paid repair and maintenance of P 15,000.
Repair and Maintenance 15,000
Cash 15,000
7. The lease bonus is amor zed over 3 years of P 60,000 annually or P40,000 for 8 months.
Unearned rent income 40,000
Rent Income (60,000 x 8/12) 40,000

8. The machinery is depreciated over 10 years of 450,000 annually (P4,500,000/ 10 years)

Deprecia on Expense 450,000
Accumulated deprecia on 450,000

Note: The deprecia on is from the date of acquisi on, January 1 and not from May 1, date of lease. Reason
for that is the machinery is acquired for leasing purposes and already AVAILABLE FOR INTENDED USE,
meaning for rental from January 1.

Idle property is subject to deprecia on as long as it is available for the intended use.

9. The ini al direct cost is recognized as expense over the lease term
Amor za on of ini al direct cost 60,000
Deferred ini al direct cost 60,000

Annual amor za on (270,000/3) 90,000

Amor za on for 8 months (90,000 x 8/12) 60,000
Note: The balance of deferred ini al direct cost shall be presented as an addi on to the carrying amount
of machinery.

Presenta on of leased machinery:

Machinery 4,500,000
Accumulated deprecia on 450,000
Carrying Amount 4,050,000
Deferred ini al direct cost 210,000
Total carrying amount 3,840,000

Deferred ini al direct cost 270,000

Amor za on for first year 60,000
Unamor zed balance 210,000

UNEQUAL PAYMENTS
Under IFRS, where opera ng lease requires unequal payments, the total cash payments for the lease
term shall be amor zed uniformly on the straight-line basis as rent income over the lease term

On January 1, 2024, Zoo Company leased office space to another en ty for a three-year period.
Under the terms of the opera ng lease, rent for the first year is P1,500,000 and rent for the next two
years, P 1,200,000 annually.

However, as an inducement to enter the lease, Zoo Company granted the lessee the first 6 months of the
lease rent- free.

2024 (1,500,000 x 6/12) 750,000

2025 1,200,000
2026 1,200,000
Total rental for 3 years 3,150,000
Average annual rental (3,150,000/3) 1,050,000

Books of Zoo Company- Lessor

2024 Cash 750,000
Rent Receivable 750,000
Rent Income 1,500,000
2025 Cash 1,200,000
Rent Receivable 150,000
Rent Income 1,050,000

Rent Income for 2024 and 2025 2,100,000

Rent Collected (750,000 + 1,200,000) 1,950,000
Rent Receivable 150,000

2026 Cash 1,200,000

Rent Receivable 150,000
Rent Income 1,050,000
Note: Rent Receivable had a zero balance on December 31, 2026 and the recorded rent income each
year is P1,050,000

B. FINANCE LEASE
A finance lease is either Direct Finance Lease or Sales Type Lease on the part of the lessor.
The main dis nc on between two is the presence or absence of a manufacturer or dealer profit or loss
A direct finance lease recognizes only interest income
A sales type lease recognizes interest income and gross profit on sale.

B. 1 DIRECT FINANCE LEASE- LESSOR

On January 1, 2024, Lessor Company leased a machinery to another en ty with the following details:

Cost of Machinery 1,518,650

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 at 12% 3.0373

Computa on:

The annual rental is computed by dividing the amount of P1,518,650 by PV factor, 3.0373
1,518,650 / 3.0373 = 500,000

Gross rentals or lease receivable (500,000 x 4 years) 2,000,000

Present value of gross rentals (equal to the net investment
in the lease or cost of the machinery) 1,518,650
Unearned Interest Income 481,350

Lease receivable 2,000,000

Machinery 1,518,650
Unearned interest income 481,350

The annual collec on of the rental is simply recorded as:

Cash 500,000
Lease Receivable 500,000

Table of Amor za on:

The unearned interest income of P 481,350 is recognized over the lease term following the effec ve
interest method.

Date Payment Interest Principal Present Value

Jan. 1, 2024 1,581,650
Dec. 31, 2024 500,000 182,238 317,762 1,200,888
Dec. 31, 2025 500,000 144,107 355,893 844,995
Dec. 31, 2026 500,000 101,399 398,601 446,394
Dec. 31, 2027 500,000 53,606 446,394

Journal Entries:

Dec. 31, 2024 Unearned Interest income 182,238

Interest Income 182,238

Dec. 31, 2025 Unearned Interest income 144,107

Interest Income 144,107

DIRECT FINANCE LEASE- WITH INITIAL DIRECT COST

On January 1, 2024, Lessor Company leased a machinery to another en ty with the following details:

Cost of Machinery 1,518,650

Annual rental payable at the end of each year 500,000
Lease Term 4 years
Useful Life of Machinery 4 years
Implicit Interest rate before ini al direct cost 12%
Present Value of annuity of 1 for 4 years at 12% 3.0373

On January 1, 2024, Lessor Company paid ini al direct cost of P66,300

The ini al direct cost is added to the cost of the machinery to determine the net investment in the lease.

Cost of machinery 1,518,650

Ini al direct cost 66,300
Net investment in the lease 1,584,950

The inclusion of ini al direct cost in the net investment in lease will have the effect of spreading the
ini al 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 1,581,950
Unearned interest income 415,050

Consequently, the ini al direct cost would decrease implicit rate in the lease. Therefore, the new implicit
rate shall be 10% with PV of OA of 1 at 10% for 4 periods at 3.1699

Present Value of Gross Rentals (500,000 x 3.1699) 1,584,950

Journal Entries:

Machinery (ini al direct cost) 66,300

Cash 66,300

Lease Receivable 2,000,000

Machinery 1,584,950
Unearned Interest Income 415,050

The annual collec on of rental is normally recorded as:

Cash 500,000
Lease Receivable 500,000

Table of Amor za on:

Date Payment Interest Principal Present Value

Jan. 1, 2024 1,584.500
Dec. 31, 2024 500,000 158,495 341,505 1,243,445
Dec. 31, 2025 500,000 124,344 375,656 867,789
Dec. 31, 2026 500,000 86,779 413,221 454,568
Dec. 31, 2027 500,000 45,432 454,568

Dec. 31, 2024 Unearned Interest income 158,495

 Interest Income 158,495

Dec. 31, 2025 Unearned Interest income 124,344

Interest Income 124,344

Note: If a statement of financial posi on is prepared by the lessor on December 31, 2022, the lease
receivable of P1,500,000 would be reported as partly current and partly noncurrent

Current Por on
Lease Receivable 500,000
Unearned Interest Income (124,344)
Carrying Amount 375,656

Non-Current Por on
Lease Receivable 1,000,000
Unearned Interest Income (132,211)
Carrying Amount 867,789

DIRECT FINANCE LEASE- WITH RESIDUAL VALUE

On January 1, 2022, Lessor Company leased a machinery to another en ty 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%
PV of 1 at 10% for 4 periods .6830
PV of an OA of 1 at 10% for 4 periods 3.1699

The machinery shall revert to the lessor at the end of the lease term because there is neither
a transfer of tle nor a purchase op on

Cost of Machinery 3,194,410

Present value of residual value (500,000 x .6830) ( 341,500)
Net investment to be recovered from rental 2,852,910
Divide by PV of an OA of 1 at 10% for 4 periods 3.1699
Annual Rental 900,000

Note: The present value of residual value is deducted from cost of asset if the machinery shall
revert to the lessor at the end of lease term. Otherwise, if the machinery shall not revert to
the lessor at the end of lease term, the residual value is completely ignored.

Gross Rentals ( 900,000 x 4) 3,600,000

Residual Value (whether guaranteed or unguaranteed) 500,000
Gross Investment 4,000,000
Cost of Machinery- net investment (3,194,410)
Unearned Interest Income 905,590

Tabel of Amor za on:

 Date Payment Interest Principal Present Value
Jan. 1, 2024 3,194,410
Dec. 31, 2024 900,000 319,441 580,559 2,613,851
Dec. 31, 2025 900,000 261,385 638,615 1,975,236
Dec. 31, 2026 900,000 197,524 702,476 1,272,760
Dec. 31, 2027 900,000 127,240 772,760 500,000

Journal Entries:

To record the direct financing lease:

Lease Receivable 4,100,000
Machinery 3,194,410
Unearned Interest Income 905,590

To record the collec on of annual rental

Cash 900,000
Lease Receivable 900,000
To record the interest income
Unearned Interest income 319,441
Interest income 319,441

When the lease expires on December 31, 2025, the machinery shall revert to the lessor.
Whether “guaranteed” or “unguaranteed”, the entry on the books of the lessor is the same

Machinery 500,000
Lease Receivable 500,000

If the fair value of the machinery is P400,000, which is lower than the residual value of
P500,000.

Under guaranteed residual value, the lessee shall pay for the difference to the lessor
Cash 100,000
Machinery 400,000
Lease Receivable 500,000

Under unguaranteed residual value, the lessee shall pay for the difference to the lessor
Loss of Finance Lease 100,000
Machinery 400,000
Lease Receivable 500,000

B. 2 SALES TYPE LEASE- LESSOR

Lessor Company is a dealer in machinery. At the beginning of current year, a machinery was
leased to Lessee Company with the ff. info:

Annual rental payable at the end of each year 400,000

Lease Term 5 years
Useful Life of Machinery 5 years
Cost of Machinery 1,000,000
Implicit interest rate 12%
Present Value of Annuity of 1 for 5 years at 12% 3.60

Gross Rentals (400,000 x 5) 2,000,000

Present Value of rentals (400,000 x 3.60) 1,440,000
Unearned Interest Income 560,000

Present Value of Rentals- Sales Revenue 1,440,000

Cost of Machinery- Cost of Goods Sold 1,000,000
Gross Income on Sale 440,000

A manufacturer or dealer lessor shall recognize income or loss for the period in accordance with
the policy followed by the en ty for outright sale.

Journal Entries:

To record the sale:

Lease Receivable 2,000,000

Sales 1,440,000
Unearned Interest Income 560,000
Note: The gross income of P440,000 is not separately recorded because it is included
already in the sales revenue
To record the cost of goods sold, assuming a perpetual system is used:

Cost of Goods Sold 1,000,000

Inventory 1,000,000

To record the collec on of the annual rental

Cash 400,000
Lease Receivable 400,000
To record the interest income

Unearned interest Income 172,800

Interest Income (12% x 1,440,000) 172,800

SALES TYPE LEASE WITH RESIDUAL VALUE

Lessor Company is a dealer in machinery

On January 1, 2022, a machinery is leased to another en ty with the following provisions:

Annual rental payable at the end of each year 800,000

Lease Term 5 years
Useful Life of Machinery 5 years
Cost of Machinery 2,000,000
Residua Value 200,000
Ini al Direct Cost paid by lessor 100,000
Implicit interest rate 10%
PV of an OA of 1 for 5 periods at 10% 3.79
PV of 1 for 5 periods at 10% 0.62
At the end of lease term on December 31, 2026, the machinery shall revert to Lessor Company.
The perpetual inventory system is used.

Note that the residual value may be guaranteed or unguaranteed

Computa ons:

Gross Rentals (800,000 x 5) 4,000,000

Residual Value Guarantee 200,000
Lease Receivable- Gross Investment 4,200,000

Present Value of Gross Rentals (800,000 x 3.79) 3,032,000

Present Value of Residual Value Guarantee (200,000 x .62) 124,000
Total Present Value- net investment 3,156,000

Lease receivable equal to gross investment 4,200,000

Total present value or net investment (3,156,000)
Unearned interest income 1,044,000

Sales revenue equal to total present value 3,156,000

Cost of goods sold- cost of machinery (2,000,000)
Ini al Direct Cost ( 100,000)
Gross Income 1,056,000

Journal Entries:

Lease Receivable 4,200,000

Cost of Goods Sold 2,000,000
Sales 3,156,000
Unearned Interest Income 1,044,000
Inventory 2,000,000

Cost of goods sold 100,000

Cash 100,000

The ini al direct cost is charged directly to cost of goods sold

Sales 3,156,000
Cost of Goods Sold 2,100,000
Gross Income 1,056,000

Cost of machinery sold 2,000,000

Ini al Direct Cost 100,000
Cost of Goods Sold 2,100,000