CHAPTER 3

LEASE ACCOUNTING

1. On January 1, 2020, an entity leased a machinery for 4 years which is the same as the useful life
of the machinery at annual rental or fixed payment of P100,000 payable at the end of each year.
The lease provides for a transfer of ownership of the underlying asset to the lessee at the end of
the lease term.
a. Prepare journal entry to record the finance lease at the commencement date of the lease.
b. Prepare journal entry to record the annual depreciation of the right of use asset.
c. Prepare the table of amortization for the lease liability.
d. Prepare journal entry to record the annual payment for years 2020 and 2021.

Answer:

100,000 x 3.0373

Entry:

Right of use asset 303,730

Lease liability 303,730

Depreciation 75,932
Accumulated Depn 75,932
(303,730/4 years)

2020
Interest expense 36,448
Lease liability 63,552
Cash 100,000

2021
Interest expense 28,821
Lease liability 71,179
Cash 100,000

2. (Certain purchase option)

Lessee Company leased a machine on January 1, 2020 with the following pertinent information:
Fixed rental payment at the end of each year 1,000,000
Lease term 10 years
Useful life of machine 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
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,
2030 by paying P500,000. The lessee is reasonably certain to exercise the purchase option at the

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 commencement date of the lease. The estimated residual value of the machine at the end of the
12-year life is P600,000.
a. Compute the cost of right of use asset and prepare journal entry to record the
acquisition of the machinery under a finance lease.
b. Prepare journal entry to record the first rental payment on December 31, 2020.
c. Prepare journal entry to record the annual depreciation.
d. Prepare the table of amortization
e. If the purchase option is exercised on January 1, 2030, prepare the journal entry to
record the payment.
f. If the purchase option is not exercised, prepare the journal entry to recognize the loss
on finance lease.

Answer:

PV of lease payments (1M x 5.65) 5,650,000

PV of purchase options (500,000 x 0.322) 161,000
Total lease liability 5,811,000

Right of use asset 5,811,000

Lease liability 5,811,000

Interest expense 697,320

Lease liability 302,680
Cash 1,000,000

5,811,000 – (1M – 697,320)

Depreciation 434,250
Accumulated Depn 434,250
(5,211,000 / 12)

5,811,000 – 600,000

Exercise purchase option

Lease liability 500,000

Cash 500,000

Nonexercise of purchase option

Acc depn (434,250 x 10) 4,342,500

Lease liability 500,000
Loss on finance lease 968,500
Right of use asset 5,811,000

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 3. Residual value guarantee
Easy Company leased an equipment on January 1, 2020 with the following information:

Fixed rental payment at the end of each year 1,000,000

Lease term 10 years
Useful life of equipment 12 years
Implicit interest rate 12%
Present value of an ordinary annuity of 1 for 4 periods at 10% 3.16987
Present value of 1 for 4 periods at 10% 0.683

Easy Company guaranteed a P200,000 residual value on December 31, 2023 to the lessor. As
long as there is a residual value guarantee, there is no more purchase option because the
equipment will revert to the lessor upon the expiration of the lease on December 31, 2023.
a. Compute the initial cost of right of use and lease liability.
b. Prepare table of amortization of lease liability.
c. Compute for the lease liability as of December 31, 2020.
d. Prepare journal entry to record the (a) acquisition of the equipment; (b) first annual
payment on December 31, 2020; (c) annual depreciation.
e. Prepare journal entry to record the (a) final annual payment on December 31, 2023
and (b) the return of the equipment to the lessor.

Answer
PV of lease payments (1M x 3.16987) 3,169,870
PV of purchase options (200,000 x 0.683) 136,600
Cost of Right of Use Asset 3,306,470

Right of use asset 3,306,470

Lease liability 3,306,470

Interest expense 330,647

Lease liability 669,353
Cash 1,000,000

5,811,000 – (1M – 697,320)

Depreciation 776,617
Accumulated Depn 776,617
(3,306,470 – 200,000 / 12)

Final annual payment

Interest expense 109,090
Lease liability 890,910
Cash 1,000,000

Return of equipment
Acc Dep 3,106,470
Lease liability 200,000
Right of use asset 3,306,470

4. Initial direct cost

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 On January 1, 2020, Simple Company leased an equipment with the following information:
Annual fixed payment in advance at the beginning of each lease year 1,000,000
Initial direct cost paid 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%
PV of an annuity of 1 in advance at 8% for 5 periods 4.3121
PV of 1 at 8% for 5 periods 0.6806
a. Compute the initial cost of right of use and lease liability.
b. Prepare table of amortization of lease liability.
c. Prepare journal entry to record the (a) acquisition of the equipment under a finance
lease; (b) the first payment on January 1, 2020; (c) accrual of the interest on
December 31, 2020; (d) depreciation for 2020.
d. Prepare journal entry to record the (a) second payment on January 1, 2021; (b)
accrual of interest on December 31, 2021; (c) depreciation for 2021.
e. Prepare journal entry to record the return of equipment to the lessor on January 1,
2025.
Answer
PV of lease payments (1M x 4,3121) 4,312,100
PV of purchase options (300,000 x 0.6806) 204,180
Lease liability 4,516,280
Lease incentives 250,000
Initial direct cost (150,000)
Cost of Right of Use Asset 4,616,280

2020
Right of use asset 4,616,280
Lease liability 4,516,280
Cash 100,000

Lease liability 1,000,000

Cash 1,000,000

Interest expense 281,302

Accrued interest payable 281,302

Depreciation 863,256
Accumulated Depn 863,256
(4,616,280 – 300,000) / 5

2021
Accrued interest expense 281,302
Lease liability 718,698

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 Cash 1,000,000

Interest expense 223,807

Accrued interest payable 223,807

Depreciation 863,256
Accumulated Depn 863,256
(4,616,280 – 300,000) / 5

Return of equipment
Acc Dep (863,256 x 5) 4,316,280
Lease liability 277,748
Accrued interest payable 22,252
Right of use asset 4,616,280

5. Unguaranteed residual value

Ezzy Company leased a warehouse on January 1, 2020 with the following information:
Annual rental payable at the end of each year 600,000
Unguaranteed residual value 200,000
Payment to lessor to obtain a long-term lease 224,000
PV of cost of restoring the asset as required by contract 400,000
Annual executory cost paid 50,000
Lease term 6 years
Useful life of equipment 8 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for 6 periods 4.36
PV of 1 at 10% for 6 periods 0.56

The lease provides for neither a transfer of title to the lessee nor a purchase option. Thus, the
equipment will revert to the lessor upon the expiration of lease on January 1, 2026.
a. Compute for the total cost of right of use asset
b. Prepare journal entry to record the (a) acquisition of the warehouse under a finance
lease; (b) payment of executory cost; (c) first rental payment on December 31, 2020
and (d) depreciation for 2020.
c. Prepare journal entry for January 1, 2026 return of the warehouse to the lessor.

Answer
PV of lease payments (600,000 x 4.36) 2,616,000
Payment to lessor to obtain a long-term lease 224,000
PV of restoration cost 400,000
Cost of Right of Use Asset 3,240,000

Right of use asset 3,240,000

Lease liability 2,616,000
Cash 224,000
Estimated liability for restoration 400,000

Executory cost 50,000

Cash 50,000

Interest expense (10% x 2,616,000) 261,600

Lease liability 338,400
Cash 600,000

Depreciation 540,000
Accumulated Depn 540,000
(3,240,000) / 6

Return to the lessor

Acc. Dep (540,000 x 6) 3,240,000

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 Equipment 3,240,000

6. Actual purchase of underlying asset

An entity purchased an equipment that it had been leasing under a finance lease for P4,000,000.
The balances of certain accounts on the date of actual purchase are:

Right of use asset 5,000,000

Accumulated depreciation 1,500,000
Lease liability 3,800,000
a. Prepare journal entry to record the cost of equipment purchased.

Answer:
Right of use asset 5,000,000
Acc Dep (1,500,000)
Carrying amount 3,500,000
Cash payment 4,000,000
Total consideration 7,500,000
Lease liability (3,800,000)
Cost of equipment purchased 3,700,000

Equipment 3,700,000
Acc Dep 1,500,000
Lease liability 3,800,000
Right of use asset 5,000,000
Cash 4,000,000

7. Extension option
An entity entered into a lease of building on January 1, 2020 with the following information:
Annual rental payable at the end of each year 500,000
Lease term 5 years
Useful life of 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, 2023, the lessee decided to extend the lease for a further 5 years.
New annual rental payable at the end of each year 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
a. Prepare the table of amortization.
b. Prepare journal entry for 2020 to record the (a) right of use asset; (b) annual
amortization (c) annual depreciation.

On January 1, 2023, the lease liability is remeasured using the new implicit interest rate
of 8%.
a. Compute for the present value of remaining rental of old lease term
b. Compute for the present value of rentals of extended lease term.
c. Compute for the new carrying amount of the right of use asset.
d. Prepare the new table of amortization.
e. Prepare journal entry to record (a) remeasurement of lease liability on January 1,
2023 (b) annual rental on December 31, 2023 (c) annual depreciation based on the
new carrying amount.

Answer

PV of lease payments (50,000 x 3.791) 1,895,500

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 Right of use asset 1,895,500
Lease liability 1,895,500

Interest expense 189,550

Lease liability 310,450
Cash 500,000

5,811,000 – (1M – 697,320)

Depreciation 379,100
Accumulated Depn 379,100
(1,895,500 / 5)

Remeasurement of lease liability

PV – 1/1/23 (500,000 x 1.783) = 891,500

Annual rental starting 2025 (600,000 x 3.993 x 0.857) = 2,053,200

PV of remaining rentals of old lease term 891,500

PV of rentals of extended lease term 2,053,200
Total PV on 1/1/23 2,944,700
PV – 12/31/22 (897,910)
Increase in lease liability 2,076,790

Right of use asset – 1/1/20 1,895,500

Acc Dep (379,100 x 3 years) (1,137,300)
Carrying amount – 12/31/22 758,200
Increase in liability – 1/1/23 2,076,790
New carrying amount – 1/1/23 2,834,990

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 Right of use asset 2,076,790
Lease liability 2,076,790

Interest expense 235,576

Lease liability 264,424
Cash 500,000

Depreciation 404,999
Accumulated Depn 404,999
(2,834,990 / 7)

8. Variable payments
On January 1, 2020, an entity entered into an 8-year lease of a floor of a building with the
following terms:
Annual rental for the first three years payable at the end of each year 300,000
Annual rental for the next five years payable at the end of each year 400,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for three periods 2.487
PV of an ordinary annuity of 1 at 10% for five periods 3.791
PV of 1 at 10% for three periods 0.751

The lease provides for neither a transfer of title to the lessee nor a purchase option.
a. Compute for the present value of annual rentals for three years.
b. Compute for the present value of annual rentals for next five years.
c. Compute for the lease liability as of January 1, 2020.
d. Prepare table of amortization.
e. Prepare journal entry to record (a) right of use asset; (b) annual rental payment (c)
annual depreciation.

Answer

PV of annual rental for 3 years (300,000 x 2.487) = 746,100

PV of annual rental for next 5 years (400,000 x 3.791 x 0.751) = 1,138,816
Total lease liability 1/1/20 = 1,884,916

Right of use asset 1,884,916

Lease liability 1,884,916

Interest expense 188,492

Lease liability 111,508
Cash 300,000

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Depreciation 235,615
Accumulated Depn 235,615
(1,884,916 / 8)

9. Lease Modification
On January 1, 2020, an entity entered into a lease agreement with the following information:
Floor space 3,000 sq. mtrs
Annual rental payable at the end of each year 100,000
Implicit rate in the lease 10%
Lease term 8 years
PV of an ordinary annuity of 1 at 10% for 8 periods 5.3349

On January 1, 2022, the entity and the lessor agreed to amend the original terms of the lease with
the following information:
Additional floor space 4,500 sq. mtrs
Increase in rental payable at the end of each year 200,000
Implicit rate in the lease 8%
PV of an ordinary annuity of 1 at 8% for 6 periods 4.6229

The increase in the rental for the additional 4,500 square meters is equivalent to the current
market value.
a. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2022.

Answer:

PV of lease payments 1/1/20 (100,000 x 5.3349) = 533,490

Right of use asset 533,490

Lease liability 533,490

Interest expense (533,490 x 10%) 53,349

Lease liability 46,651
Cash 100,000

Depreciation 66,686
Accumulated Depn 66,686
(533,490 / 8)

Modification

PV of the additional lease payment 1/1/22 (200,000 x 4.6229) = 924,580

Right of use asset 924,580

Lease liability 924,580

Interest expense (533,49 x 10%) 73,966

Lease liability 126,034
Cash 200,000

Depreciation 154,097
Accumulated Depn 154,097
(924,580 / 6 years)

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 10. Lease Modification (extension of lease term)
On January 1, 2020, an entity entered into a lease for office space with the following information:
Annual rental payable at the end of each year beginning Dec 31, 2020 200,000
Lease term 5 years
Implicit rate in the lease 9%
PV of an ordinary annuity of 1 for 5 periods at 9% 3.89

On January 1, 2022, the entity and the lessor agreed to amend the original lease by extending the
lease term by 3 more years with the following information:
Annual rental payable at the end of each year beginning Dec 31, 2022 200,000
Implicit rate in the lease 11%
PV of an ordinary annuity of 1 at 11% for 6 periods 4.231
a. Prepare amortization schedule for 2020 and 2021.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
c. Compute for the amount increase in lease liability.
d. Prepare the revised amortization schedule.
e. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2022.

Answer:

PV of lease liability on 1/1/20 (200,000 x 3.89) = 778,000

Right of use asset 778,000

Lease liability 778,000

Interest expense 70,020

Lease liability 129,980
Cash 200,000

Depreciation 155,600
Accumulated Depn 155,600
(778,000 / 5 years)

New lease liability due to extension

PV of lease payments om 1/1/22 as a result of the 846,200

extension (200,000 x 4.231)
Carrying amount on 1/1/22 before extension (506,342)
Increase in lease liability 339,858

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 Right of use asset 339,858
Lease liability 339,858

Interest expense 93,082

Lease liability 106,918
Cash 200,000

Depreciation 134,443
Accumulated Depn 134,443

Cost of right of use asset 778,000

Acc Depn 12/31/21 (155,600 x 2) (311,200)
Carrying amount – 12/31/21 466,800
Increase in lease liability 339,858
Adjusted carrying amount – 1/1/22 806,658

Extended lease term (5 – 2 + 3 = 6)

Annual depreciation (806,658 / 6) = 134,443

11. Lease Modification (decrease in scope of lease)

On January 1, 2020, an entity entered into a lease of office space with the following information:

Floor space 800 sq mtrs

Annual rental payable at the end of each year 40,000
Lease term 10 years
Implicit rate in the lease 8%
PV of an ordinary annuity of 1 for 8% for 10 periods 6.7101
PV of lease payments – January 1, 2020 (40,000 x 6.7101) 268,404

a. Prepare table of amortization for 2020 and 2021.

b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
Amendment of the lease
On January 1, 2022, the lessee and the lessor agreed to amend the original terms of the lease with
the following information:
Floor space 480 sq. mtrs
Annual rental payable at the end of each year 30,000
Implicit rate in the lease 10%
PV of an ordinary annuity of 1 at 10% for 8 periods 5.3349

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 c. Compute for the termination gain.
d. Compute for the carrying amount of old lease on Jan 1, 2022.
e. Prepare the revised table of amortization
f. Prepare necessary journal entries for 2022.

Answer

Before lease modification

Right of use asset 268,404

Lease liability 268,404

Interest expense 21,472

Lease liability 18,528
Cash 40,000

Depreciation (268,404 / 10) 26,840

Accumulated Depn 26,840

Decrease in scope

Decrease in carrying amount of lease liability 91,946

(229,866 x 40%)
Decrease in carrying amount of right of use asset (85,890)
(214,724 x 40%)
Termination gain 6,056

Cost of right of use asset 268,404

Acc Deprn (53,680)
Carrying amount – 12/31/21 214,724

Lease liability – 1/1/22 229,866

Reduction of old lease liability (91,946)
Remaining old lease liability 1/1/22 137,920

PV of lease payments 1/1/2022 as a result of the 160,047

decrease in scope (30,000 x 5.3349)
Carrying amount of old lease liability on 1/1/22 (137,920)
Increase in lease liability 22,127

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 Lease liability 91,946
Acc Depn 21,472
Right of use asset 107,362
Termination gain 6,056

Right of use asset 22,127

Lease liability 22,127

Interest expense 16,005

Lease liability 13,995
Cash 30,000

Depreciation (150,961 / 8) 18,870

Accumulated Depn 18,870

12. Lease modification – change in rental

On January 1, 2020, an entity lease equipment with the following information:
Annual rental payable at the end of each year 80,000
Lease term 6 years
Implicit rate in the lease 7%
PV of an ordinary annuity of 1 at 7% for 6 periods 4.7665
PV of lease payments – January 1, 2020 (80,000 x 4.7665) 381,320
a. Prepare table of amortization for 2020 to 2021.
b. Prepare journal entry to record (a) right of use asset; (b) Annual rental payment; (c)
annual depreciation for year 2020.
Amendment of the lease
On January 1, 2023, the entity and the lessor agreed to amend the original terms of the lease by
reducing the lease payment to P70,000 and increasing the implicit rate to 9%. The present value
of an ordinary annuity of 1 at 9% for 3 periods is 2.5313.
c. Compute for the decrease in lease liability.
d. Compute for the adjusted carrying amount – January 1, 2023
e. Prepare necessary journal entries for 2023

Before lease modification

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 Right of use asset 381,320
Lease liability 381,320

Interest expense 26,692

Lease liability 53,308
Cash 80,000

Depreciation (381,320 / 6) 63,553

Accumulated Depn 63,533

Lease modification

Modified lease liability 1/1/23 (70,000 x 2.5313) 177,191

Carrying amount of lease liability (209,941)
Decrease in lease liability (32,750)

Cost of right of use asset 381,320

Acc Dep (63,553 x 3) (190,659)
Carrying amount – 1/1/23 190,661
Decrease in lease liability (32,750)
Adjusted carrying amount 1/1/23 157,911

Right of use asset 32,750

Lease liability 32750

Interest expense 15,947

Lease liability 54,053
Cash 70,000

Depreciation (157,911 / 3) 52,637

Accumulated Depn 52,637

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 13. Operating lease – Lessor
Prepare journal entries to the following transactions:
1. On January 1, 2020, Simple Company purchased a machinery for P3,000,000 cash for
the purpose of leasing it. The machine is expected to have a 10-year life and no
residual value.

Machinery 3,000,000
Cash 3,000,000
2. On April 1, 2020, Simple Company leased the machine to another entity for 3 years at
a monthly rental of P50,000, payable at the beginning of every month.

Cash (50,000 x 9) 450,000

Rent Income 450,000
3. On April 1, 2020, Simple Company received a security deposit of P600,000 to be
refunded upon the lease expiration.

Cash 600,000
Liability for rent deposit 600,000
4. In addition to the rental, Simple Company received from the lessee a lease bonus of
P120,000 on January 1, 2020.

Cash 120,000
Unearned rent income 120,000
5. On April 1, 2020, Simple Company paid initial direct cost of P300,000. Such cost are
directly attributable to negotiating and arranging the operating lease.

Deferred initial direct cost 300,000

Cash 300,000
6. During the year, Simple Company paid repair and maintenance of P20,000.

Repair and maintenance 20,000

Cash 20,000
7. The lease bonus is amortized over 3 years or P40,000 annually.

Unearned rent income 30,000

Rent income (40,000 x 9/12) 30,000
8. The machinery is depreciated over 10 years or P300,000 annually.

Depreciation 300,000
Acc Depn 300,000
9 The initial direct cost is recognized as expense over the lease term.

Amotn of initial direct cost 75,000

Deferred initial direct cost 75,000
(300,000 / 3 x 9/12)

14. Unequal rental payments

Aye Company lease office space to another entity for a three-year period beginning January 1,
202. Under the terms of the operating lease, rent for the first year is P1,000,000 and rent for the
next two years , P1,250,000 annually. However, as an inducement to enter the lease, Aye granted
the lessee the first six months of the lease rent-free.
a. Compute for the average annual rental.
b. Prepare cash collections for the year 2020, 2021 and 2022.

Answer:

(1,000,000 / 2) + 1,250,000 + 1,250,000 = 3,000,000

Ave Annual Rent = 3,000,000 / 3 = 1,000,000

2020 Cash 500,000

Rent Receivable 500,000
Rent income 1,000,000

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2021 Cash 1,250,000
Rent Receivable 250,000
Rent income 1,000,000

2022 Cash 1,250,000

Rent Receivable 250,000
Rent income 1,000,000

15. Direct financing lease

On January 1, 2020, Lessor Company leased a machinery to another entity 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%
PV of annuity of 1 for 4 years at 12% 3.0373

a. Compute for the lease receivable, cost of the machinery and unearned interest
income. Prepare also the corresponding journal entry.
b. Prepare journal entry to record the annual collection of the rental.
c. Prepare table of amortization
d. Prepare journal entry to record the recognition of interest income for the year 2020 &
2021.

Answer:

Gross rental or lease receivable (500,000 x 4 2,000,000

years)
PV of gross rentals 1,518,650
Unearned interest income 481,350

Lease receivable 2,000,000

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

Cash 500,000
Lease receivable 500,000

2020
Unearned interest income 182,238
Interest income 182,238

2021
Unearned interest income 144,107
Interest income 144,107

16. Direct financing lease – with initial direct cost

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 Assuming the same details as above exempt that, on January 1, 2020, Lessor Company paid
initial direct cost of P66,300.
a. Compute for the new interest rate.
b. Prepare journal entry to record payment of initial direct cost, lease receivables and annual
collection of rental.
c. Prepare the table of amortization.
d. Prepare journal entry to record the recognition of interest income for the year 2020 &
2021.

Answer:

Cost of machinery 1,518,650

Initial direct cost 66,300
Net investment income 1,584,950

Gross rental or lease receivable (500,000 x 4 2,000,000

years)
PV of gross rentals 1,584,950
Unearned interest income 415,050

Trial and error = new implicit rate is 10%

500,000 x 3.1699 = 1,584,950

Machinery (initial indirect cost) 66,300

Cash 66,300

Lease receivable 2,000,000

Machinery 1,584,950
Unearned interest income 415,050

Cash 500,000
Lease receivable 500,000

2020
Unearned interest income 158,495
Interest income 158,495

2021
Unearned interest income 124,344
Interest income 124,344

17. Direct financing lease – with residual value

On January 1, 2020, Lessor Company leased a machinery to another entity with the following
details:
Cost of machinery 3,194,410
Residual value 500,000

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 Useful life and lease term 4 years
Implicit interest rate 10%
PV of 1 at 10% for 4 periods 0.6830
PV of an ordinary annuity of 1 at 10% for 4 periods 3.1699
a. Compute for the net investment to be recovered from rental and annual rental.
b. Compute for the gross investment and unearned interest income.
c. Prepare table of amortization
d. Prepare journal entry to record (a) direct financing lease; (b) collection of annual
rental; (c) interest income (d) machinery revert to the lessor on Dec 31, 2023.
e. Assuming the fair value of the machinery is 400,000 which is lower than the residual
value of P500,000 (a) under the guaranteed scenario, prepare the journal entry (b)
under the unguaranteed scenario, prepare also the journal entry.

Answer:

Cost of machinery 3,194,410

PV of residual value (500,000 x 0.683) (341,500)
Net investment to be recovered from rental 2,852,910
Divided by PV of OA 3.1699
Annual rental 900,000

Gross rentals (9--,000 x 4) 3,600,000

Residual value (whether guaranteed or 500,000
unguaranteed)
Gross investment 4,100,000
Cost of machinery – net investment (3,194,410)
Unearned interest income 905,590

Lease receivable 4,100,000

Machinery 3,194,410
Unearned interest income 905,590

Cash 900,000
Lease receivable 900,000

Unearned interest income 319,441

Interest income 319,441

Machinery 500,000
Lease receivable 500,000

Guaranteed scenario

Cash 100,000
Machinery 400,000
Lease receivable 500,000

Unguaranteed scenario

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 Loss on finance lease 100,000
Machinery 400,000
Lease receivable 500,000

18. Direct financing lease – transfer of title to lessee

On January 1, 2020, Lessor Company leased a machinery to another entity with the following
details:
Cost of machinery 3,449,600
Residual value 500,000
Useful life and lease term 5 years
Implicit interest rate 8%
PV of an ordinary annuity of 1 in advance at 8% for 5 periods 4.312

The annual rental is payable in advance on January 1 of each year starting January 1, 2020. The
lease provides for a transfer of title to the lessee at the end of the lease term.
a. Compute for the annual rental and the unearned interest income.
b. Prepare table of amortization
c. Prepare journal entry to record the (a) lease receivables (b) rental payment (c) interest
income for year 2020 and 2021.

Answer:

Cost of machinery 3,449,600

Divided by PV of OA 4.312
Annual rental 800,000

Gross rentals (9--,000 x 4) 4,000,000

Cost of machinery – net investment (3,449,600)
Unearned interest income 550,400

2020
Lease receivable 4,000,000
Machinery 3,449,600
Unearned interest income 550,400

Cash 800,000
Lease receivable 800,000

Unearned interest income 211,968

Interest income 211,968

2021

Cash 800,000

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 Lease receivable 800,000

Unearned interest income 164,925

Interest income 164,925

19. (Sales type lease) Lessor Company is a dealer in machinery. On January 1, 2020, a machinery
was leased to Lessee Company with the following provisions:
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%
PV of annuity of 1 for 5 years at 12% 3.60
a. Compute for the unearned interest income and gross profit on sale.
b. Prepare journal entry to record (a) sale; (b) cost of goods sold; (c) collection of the
annual rental; (d) interest income for 2020.

Answer:

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

PV of rentals (400,000 x 3.6) 1,440,000
Unearned interest income 560,000

PV of rentals – sales 1,440,000

Cost of machinery – cost of goods sold 1,000,000
Gross profit on sale 440,000

Lease receivable 2,000,000

Sales 1,440,000
Unearned interest income 560,000

Cost of goods sold 1,000,000

Inventory 1,000,000

Cash 400,000
Lease receivable 400,000

Unearned interest income 172,800

Interest income 172,800

20. (Sales type lease with residual value) Lessor Company is a dealer in machinery. On January 1,
2020, a machinery was leased to Lessee Company 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
Estimated residual value 200,000
Initial direct cost paid by lessor 100,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.7908
PV of 1 for 5 periods at 10% 0.6209

At the end of the lease term on December 31, 2024, the machinery will revert to Lessor
Company. The perpetual inventory system is used.
a. Compute for the unearned interest income and gross income.
b. Prepare journal entry to record the sale and the payment for initial direct cost.
c. Assume the residual value is unguaranteed, compute for the unearned interest income
and gross income.

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 d. Prepare table of amortization.
e. Prepare journal entry to record the revert to the Lessor Company on the termination
date on December 31, 2024.

Answer:

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

Residual value guarantee 200,000
Lease receivable – gross investment 4,200,000

PV of gross rentals (800,000 x 3.7908) 3,032,640

PV of residual value guarantee (200,000 x 0.6209) 124,180
Total PV – net investment 3,156,820

Lease receivable 4,200,000

Total PV (3,156,820)
Unearned interest income 1,043,180

Sales equal to total PV 3,156,820

Cost of machinery – cost of goods sold (2,000,000)
Initial direct cost (100,000)
Gross income 1,056,820

Lease receivable 4,200,000

Cost of goods sold 2,000,000
Sales 3,156,820
Unearned interest income 1,043,180
Inventory 2,000,000

Cost of goods sold 100,000

Cash 100,000

Unguaranteed residual value

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

Residual value guarantee 200,000
Lease receivable – gross investment 4,200,000

PV of gross rentals (800,000 x 3.7908) 3,032,640

PV of residual value guarantee (200,000 x 0.6209) 124,180
Total PV – net investment 3,156,820

Lease receivable 4,200,000

Total PV (3,156,820)
Unearned interest income 1,043,180

Sales equal to total PV 3,156,820

Cost of machinery – cost of goods sold (2,000,000)
Initial direct cost (100,000)
Gross income 1,056,820

Same with guarantee residual value

Lease receivable 4,200,000

Cost of goods sold 2,000,000
Sales 3,156,820
Unearned interest income 1,043,180

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 Inventory 2,000,000

Cost of goods sold 100,000

Cash 100,000

Cash 800,000
Lease receivable 800,000

Unearned interest income 315,682

Interest income 315,682

Return of asset to the lessor

Guarantee or unguaranteed

Inventory (machinery) 200,000

Lease receivable 200,000

Cash 50,000
Inventory 150,000
Lease receivable 200,000

21. (Sales type lease with purchase option) An entity is a dealer in equipment. On January 1, 2020,
an equipment is leased to another entity with the following provisions:
Annual rental payable at the end of each year 500,000
Lease term 4 years
Useful life of equipment 5 years
Cost of equipment 1,000,000
Initial direct cost paid by lessor 100,000
Purchase option 200,000
Implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for 4 periods 3.312
PV of 1 at 8% for 4 periods 0.735

It is reasonably certain that the lessee will exercise the purchase option on December 31, 2023.
a. Compute for the unearned interest income and gross income.
b. Prepare journal entry to record the sale.
c. Prepare table of amortization and the necessary journal entries.
d. Prepare journal entry to record the exercise of purchase option by the lessee on
December 31, 2023.

Answer

Gross rentals (500,000 x 5) 2,000,000

Residual value guarantee 200,000
Lease receivable – gross investment 2,200,000

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 PV of gross rentals (500,000 x 3.312) 1,656,000
PV of residual value guarantee (200,000 x 0.735) 147,000
Total PV – net investment 1,803,000

Gross investment 2,200,000

Net investment (1,803,000)
Unearned interest income 397,000

Sales equal to total PV 1,803,000

Cost of machinery – cost of goods sold 1,100,000
Gross income 703,000

Cost of equipment 1,000,000

Initial direct cost 100,000
Cost of goods sold 1,100,000

Lease receivable 2,200,000

Cost of goods sold 1,100,000
Sales 1,803,000
Unearned interest income 397,000
Inventory 1,000,000
Cash 100,000

Cash 800,000
Lease receivable 800,000

Unearned interest income 144,240

Interest income 144,240

Exercise of purchase option

Cash 200,000
Lease receivable 200,000

22. (Actual sale of underlying asset) An entity actually sold an equipment that it had been leasing
under a sales type lease for P3,500,000. The following balances are associated with the finance
lease on the books of the lessor on the date of sale:
Lease receivable 5,000,000
Unearned interest income 1,200,000
Compute for the loss on sale of leased equipment and prepare journal entry.

Answer:
Sales price 3,500,000
Carrying amount of lease receivable:
Lease receivable 5,000,000
Unearned interest income (1,200,000) 3,800,000
Loss on sale of leased equipment (300,000)

Journal entry to record the actual sale

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 Cash 3,500,000
Unearned interest income 1,200,000
Loss on sale of leased equipment 300,000
Lease receivable 5,000,000

23. (Sales and leaseback – sale price at fair value) At the beginning of the current year, an entity
sold a machinery with a remaining life of 10 years for P2,000,000 which is equal to the fair value
of the machinery. The entity immediately leased the machinery back for 1 year at the prevailing
annual rental of P300,000. The machinery has a carrying amount of P1,800,000, net of
accumulated depreciation of P1,200,000.
a. Prepare journal entry using the books of seller-lessee to record the sale and annual rental.
b. Prepare journal entry using the books of buyer-lessor to record the purchase, annual
rental and depreciation of the machinery.

Answer

Books of seller-lessee

Cash 2,000,000
Acc Dep 1,200,000
Machinery 3,000,000
Gain on right transferred 200,000
To record sale

Rent expense 300,000

Cash 300,000
To record annual rent

Books of buyer-lessor

Machinery 2,000,000
Cash 2,000,000
To record purchase

Cash 100,000
Rent income 100,000
To record annual rent

Depn 200,000
Acc Depn 200,000
2,000,000/10

24. (Sale price at fair value) On January 1, 2020, an entity sold an equipment with remaining life of
10 years and immediately leased it back for 4 years at the prevailing market rental.
Sale price at fair value 6,000,000
Carrying amount of equipment 4,500,000
Annual rental payable at the end of each year 800,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 at 10% for four periods 3.170
a. Compute for the lease liability and prepare table of amortization
b. Compute for the cost of right of use asset.
c. Compute for the total gain to be recognized.
d. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of the right of
use asset.
e. In the books of buyer-lessor, prepare journal entry to record the (a) purchase of the
underlying asset; (b) annual rental; (c) annual depreciation of equipment.

Answer

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PV of rentals (800,000 x 3.17) = 2,536,000

Cost of right of use asset (2,536,000 / 6M x 4.5M) = 1,902,000

Total Gain (6M – 4.5M = 1.5M)

Books of seller-lessee

Cash 6,000,000
Right of use asset 1,902,000
Equipment 4,500,000
Lease liability 2,536,000
Gain on right transferred 866,000

Interest expense (10% x 2,536,000) 253,600

Lease liability 546,400
Cash 800,000

Depn (1,902,000 / 4) 475,500

Acc Depn 475,500

Books of buyer-lessor

Equipment 6,000,000
Cash 6,000,000
To record purchase

Cash 800,000
Rent income 800,000
To record annual rent

Depn 600,000
Acc Depn 600,000
6,000,000/10

25. (Sales price above fair value) On January 1, 2020, an entity sold a building with remaining life
of 20 years and immediately leased it back for 5 years.
Sale price 20,000,000
Fair value of building 18,000,000
Carrying amount of building 10,800,000
Annual rental payable at the end of each year 1,500,000
Implicit interest rate 12%
PV of an ordinary annuity of 1 at 12% for five periods 3.60
a. Compute for the (a) lease liability; (b) excess sales price over fair value; (c) cost of
right of use asset; (d) right transferred to buyer-lessor; (e) adjusted total gain.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
building; (b) annual rental lease; (c) annual rental related to financing; (d)
depreciation of the building.
d. Prepare amortization related to financial asset.

Answer

Lease liability (1,500,000 x 3.60) = 5,400,000

PV of lease liability related to rental (5.4M – (20M – 18M)) = 3.4M

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Cost of right of use asset (3.4M / 18M x 10.80M) = 2,040,000

Adjusted total gain (18M – 10.80M) = 7.2M

Books of seller-lessee

Cash 20,000,000
Right of use asset 2,040,000
Building 10,800,000
Lease liability 5,400,000
Gain on right transferred (squeeze) 5,840,000

Interest expense (10% x 5,400,000) 648,000

Lease liability 852,000
Cash 1,500,000

Depn (2,040,000 / 5) 408,000

Acc Depn 408,000

Books of buyer-lessor

Building 18,000,000
Financial assets 2,000,000
Cash 20,000,000
To record purchase

Cash 944,444
Rent income 944,444
To record annual rent

Cash 555,556
Financial asset 315,556
Interest income 240,000

Depn 900,000
Acc Depn 900,000
18,000,000/20

Allocation of the annual rent

Present value Fraction Allocation

Rental income 3,400,000 3,400/5,400 944,444
Financial asset 2,000,000 2,000/5,400 555,556
Total PV 5,400,000 1,500,000

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 26. (Sale price below fair value) On January 1, 2020, an entity sold an equipment with remaining
life of 8 years and leased it back for 5 years.
Sale price 5,000,000
Fair value of building 6,000,000
Carrying amount of building 4,800,000
Annual rental payable at the end of each year 900,000
Implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for five periods 3.99

a. Compute for the (a) lease liability; (b) cost of right of use asset; (c) gain to be
recognized; (d) gain not to be recognized; (e) total gain.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
equipment; (b) annual rental; (c) depreciation of the equipment.
d. Prepare amortization table.

Answer

PV rentals (900,000 x 3.99) = 3,591,000

Total lease liability (3,591,000 + (6M – 5M)) = 4,591,000

Cost of right of use asset (4,591,000 / 6M x 4.8M) = 3,672,800

Total gain (6M – 4.8M) = 1.2M

Books of seller-lessee

Cash 5,000,000
Right of use asset 3,672,800
Equipment 4,800,000
Lease liability 3,591,000
Gain on right transferred (squeeze) 281,800

Interest expense (8% x 3,591,000) 287,280

Lease liability 612,720
Cash 900,000

Depn (3,672,800 / 5) 734,56

Acc Depn 734,560

Books of buyer-lessor

Equipment 5,000,000
Cash 5,000,000
To record purchase

Cash 900,000
Rent income 900,000
To record annual rent

Depn 625,000
Acc Depn 625,000
5,000,000/8

27. (Sale price at fair value with loss) On January 1, 2020, an entity sold a building with remaining
life of 25 years and immediately leased it back for 3 years.

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 Sale price at fair value 10,000,000
Carrying amount 12,000,000
Annual rental payable at the end of each year 500,000
Implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for three periods 2.58

a. Compute for the (a) lease liability; (b) cost of right of use asset; (c) right transferred
to buyer-lessor; (d) loss to be recognized; (d) loss not to be recognized; (e) total loss.
b. In the books of seller-lessee, prepare journal entry to record the (a) sale and
leaseback; (b) annual rental for the first year; (c) annual depreciation of right of use
asset.
c. In the books of buyer-lessor, prepare journal entry to record (a) purchase of the
building; (b) annual rental; (c) depreciation of the building.
d. Prepare amortization table.

Answer:

PV of rentals (500,000 x 2.58) = 1,290,000

Cost of right of use asset (1,290,000 x 10M / 12M) = 1,548,000

Total loss (10M – 12M) = 2M

Books of seller-lessee

Cash 10,000,000
Right of use asset 1,548,000
Loss on right transferred 1,742,000
Building 12,000,000
Lease liability 1,290,000

Interest expense (8% x 1,290,000) 103,200

Lease liability 396,800
Cash 500,000

Depn (1,548,000 / 3) 516,000

Acc Depn 516,000

Books of buyer-lessor

Building 10,000,000
Cash 10,000,000
To record purchase

Cash 500,000
Rent income 500,000
To record annual rent

Depn 400,000
Acc Depn 400,000
10,000,000/25

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