Finance

Lease - Lessee

Maria Evelyn Sabucido

Definitions
Guaranteed residual value is
that part of the residual value Unguaranteed residual value is that
which is guaranteed by the portion of the residual value of the leased
lessee or by party related to the asset, the realization of which by the
lessee, the amount of guarantee lessor is not assured or is guaranteed
being the maximum amount that solely by a party related to the lessor
could in any event become
payable.
Contingent rent is that portion Executory costs are ownership
of the lease payment that is expenses such as maintenance,
not fixed in amount but is taxes and insurance for the
based on a factor other than leased property. Such executory
just the passage of time. costs are expensed immediately
when incurred.
Initial direct costs are often
incurred in connection with
specific leasing activities as
in negotiating and securing
leasing arrangements
Illustration
On January 1, 2015, an entity leased a machinery for
4 years which is the same as the useful life of the
machinery at annual rental of P100,000, payable at
the end of each year.
The lease provides for a transfer of ownership of the
leased asset to the lessee at the end of the leased
term.
 The present value of annual payment of P100,000 for 4
years using a 12% implicit interest rate is determined as
follows:

Present value P100,000 x present value of an

= ordinary annuity of 1 for 4 years at
Present value computation Your Content Here
12%.
= P100,000 x 3.0373
= P303,730
The journal entry to record
Your Content the finance lease at the
Here
commencement of the lease:
Jan. 1, 2015 Machinery 303,730
Lease liability 303,730
 Depreciation of leased asset

PAS 17, paragraph 28,
provides that if there is
reasonable certainty that the
lessee will obtain ownership by
the end of the lease term,
depreciation is based on the
useful life of the leased asset.
Otherwise, the
leased asset is
depreciated over the
shorter of the lease
term or useful life of
the asset.
Thus, if the finance lease
qualifies under the
“transfer of ownership”
and “bargain purchase
option” criteria, the
depreciation is based on
the useful life of the asset.

2015
Dec. 31 Depreciation 75,932 If the finance lease qualifies under
the “75%” and “90%” criteria, the
Accumulated leased asset is depreciated over
depreciation 75,932 the lease term or useful life of the
(P303,730/4 years) asset whichever is shorter.
 It should be pointed that if in
addition to the annual rental, the
lessee is required to pay the
executory costs such as real
estate taxes, insurance, and
maintenance, the executory Executory
costs are recorded by debiting costs
the proper expense accounts
and crediting the cash account.
The executory costs are not
capitalized as cost of the leased
asset.
 Illustration – Bargain purchase option

Lessee Company leased a machine on January 1, 2015 with the following pertinent information:

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

Lease term 10 years
Useful life of machine 12 years
Incremental borrowing rate of lessee 14%
Implicit interest rate of lessor known to lessee 12%
Present value of an ordinary annuity of 1 for 10 periods at
14% 5.216
12% 5.650
Present value of 1 for 10 periods at
14% 0.270
12% 0.322
Lessee
. Company has the option to purchase
the machine upon the lease expiration on
January 1, 2025 by paying P500,000 which is
sufficiently lower than the expected fair value
of the machine on January 1, 2025. At the
inception of the lease, the bargain purchase
option is reasonably certain to be exercised.
The estimated residual value of the machine
at the end of the 12-year life is P600,000.
Capitalized cost of the machine
Present value of rentals (1,000,000 x 5.65) 5,650,000
Present value of bargain purchase option ( 500,000 x .322) 161,000
Total lease liability 5,811,000

Note that the present value factor applicable to 12% is used in computing the present value of
the minimum lease payments.

In calculating the present value of the minimum lease payments, the discount factor is the
implicit interest rate if this is practicable to determine. The implicit interest rate is usually known
to the lessee.
Journal entries

1. To record the acquisition of the machinery under a finance lease:

D
Jan. 1, 2015 Machinery 5,811,000

D
D

D
Lease liability 5,811,000

D
D

D
D

D
2. To record the first rental payment on December 31, 2015:
Dec.
Lease 2015 –Interest
31, liability Januaryexpense
1, 2015 697,320 5,811,000
Lease liability
Payment on December 31, 2015 302,680
1,000,000
Cashx 5,811,000)
Interest for 2015 (12% (697,320) 1,000,000
302,680
Lease liability – December 31, 2015 5,508,320
3. To record the annual depreciation:
Dec. 31, 2015 Depreciation 434,250
The asset is depreciated over the useful life because there is a bargain
purchase option. Accumulated depreciation 434,250
(5,211,000/12)
The depreciable amount is equal to the cost of P5,811,000 minus the
residual value of P600,000 or P5,211,000.
 Table of amortization

Date Payment Interest Principal Present value

1/1/2015 5,811,000
12/31/2015 1,000,000 697,320 302,680 5,508,320
12/31/2016 1,000,000 660,998 339,002 5,169,318
12/31/2017 1,000,000 620,318 379,682 4,789,636
12/31/2018 1,000,000 574,756 425,244 4,364,692
12/31/2019 1,000,000 523,727 476,273 3,888,119
12/31/2020 1,000,000 466,574 533,426 3,354,694
12/31/2021 1,000,000 402,563 597,437 2,757,257
12/31/2022 1,000,000 330,871 669,129 2,088,128
12/31/2023 1,000,000 250,575 749,425 1,338,703
12/31/2024 1,000,000 161,297 838,703 500,000

Jan. 1, 2025 Lease liability 500,000

Cash 500,000
 Non exercise of bargain purchase option
However, if the bargain purchase option is not exercised, a loss is recognized equal to the
difference between the carrying amount of the machinery and the lease liability on January
1, 2025.
Machinery 5,811,000
Jan. 1, 2025 Accumulated depreciation 4,342,500
Accumulated depreciation
Lease liability 500,000
(434,250 x 10 years) 4,342,500
Loss on finance lease 968,500
Carrying amount – January 1, 2025 1,468,500
Machinery 5,811,000
Lease liability – January 1, 2025 500,000
Loss on finance lease 968,500
 Problem 11-11
Veronica company negotiated a long term lease for newly
constructed building. On January 1, 2015, the entity took
possession of the building. The building has useful life of 20 years.
The lease runs for 15 years from January 1, 2015. The lease
contains neither a transfer of title nor a bargain purchase option.
Annual payments of P1,000,000 are payable to the lessor on
December 31 of each of the 15 years of the lease term. The lease
was negotiated to assure the lessor a 10% rate of return. Present
value factors are:

PV of an ordinary annuity of 1 at 10% for 15 periods 7.606

PV of an annuity of 1 in advance at 10% for 15 periods 8.367

Required:
Prepare journal entries on the books of Veronica Company for the
year 2015
 Problem 11-13
Lawton Company leased a machinery with a fair value of P2,800,000 on January 1, 2015. The
machinery has an estimated useful life of 8 years.
The contract is a six – year noncancelable lease with a 10% implicit interest rate.
The lease contains neither a transfer of title nor a bargain purchase option. The lease requires annual
payments of P500,000 beginning January 1, 2015.
The entity guaranteed a residual value of P400,000 when the machinery is returned to the lessor
upon the lease expiration.
The present value of an annuity due of 1 at 10% for six periods is 4.7908. The present value of 1 at
10% for 6 periods is .5645.

Required:
1. Determine whether the lease is a finance lease.
2. Prepare a table of amortization of the lease liability and interest expense.
3. Prepare journal entries for 2015 and 2016.
4. Prepare journal entry on January 1, 2021 to record the return of the machinery to the lessor.
Assume the fair value of the asset is P450,000.
5. Prepare journal entry on January 1, 2021 to record the return of the machinery to the lessor.
Assume the fair value of the asset is P300,000.
 Problem 11 - 22
East Company leased a new machine from North Company on January 1, 2015 under a lease with the
following information:

Annual rental payable at beginning of each lease year 400,000

Lease term 10 years
Useful life of machine 12 years
Implicit interest rate 14%
Present value of an annuity of 1 in advance for 10
periods at 14% 5.95
Present value of 1 for 10 periods at 14% 0.27

East Company has the option to purchase the machine on January 1, 2025, by paying P500,000 which
approximates the expected fair value of the machine on the option exercise date.

What is the initial cost of the leased asset to be recognized by East Company?
a. 2,515,000
b. 2,380,000
c. 2,245,000
d. 1,980,000
 Problem 11 - 32

Neal Company entered into a nine year finance lease on a warehouse on December
31, 2015. Lease payment of P520,000 which included real estate taxes and other
executory cost of P20,000 are due annually beginning on December 31, 2016 and
every December 31 thereafter. The interest rate implicit in the lease is 9%. The rounded
present value of an ordinary annuity of 1 for nine years at 9% is 5.6. What amount
should be reported as lease liability on December 31, 2015?

a. 2,800,000
b. 2,912,000
c. 4,500,000
d. 4,680,000
 Problem 11 - 33
Num Company leased machinery from Chin Company on January 1, 2015 for a 10-year
period. The useful life of the asset is 20 years. Equal annual payments under the lease are
P200,000 and are due on January 1 of each year starting January 1, 2015. The present value
on January 1, 2015 of the lease payments over the lease term discounted at 10% was
P1,352,000. The incremental borrowing rate was 12%. The lease is appropriately accounted
for as a finance lease because there is a very nominal bargain purchase option.

1. What is the finance lease liability to be reported as noncurrent on December 31, 2015?
a. 1,215,920
b. 1,090,240
c. 1,067,200
d. 973,920
2. What is the interest expense for 2015?
a. 200,000
b. 115,200
c. 106,720
d. 0

3. What is the depreciation for 2015?

a. 135,200
b. 115,200
c. 67,600
d. 20,000
Thank You