1

LEASES SETC

Problem

1. Angel Co. leased a new machine to Oz Co. on January 1, year 1. The lease is an operating lease and
expires on January 1, year 6. The annual rental is 90,000. Additionally, on January 1, year 1, Oz paid
50,000 to Angel as a lease bonus and 25,000 as a security deposit to be refunded upon expiration of the
lease. In Angel’s year 1 income statement, the amount of rental revenue should be
a. 140,000
b. 125,000
c. 100,000
d. 90,000

2. Amara Co. leased office premises to Kaila, Inc. for a five-year term beginning January 2, year 1. Under
the terms of the operating lease, rent for the first year is 8,000 and rent for years two through five is
12,500 per annum. However, as an inducement to enter the lease, Amara granted Kaila the first six
months of the lease rent-free. In its December 31, year 1 income statement, what amount should Amara
report as rental income?
a. 12,000
b. 11,600
c. 10,800
d. 8,000

3. On January 1, year 1, Kaila Co. leased a building to Jerome under an operating lease for ten years at
50,000 per year, payable the first day of each lease year. Kaila paid 15,000 to a real estate broker as a
finder’s fee. The building is depreciated 12,000 per year. For year 1, Kaila incurred insurance and
property tax expense totaling 9,000. Kaila’s net rental income for year 1 should be
a. 27,500
b. 29,000
c. 35,000
d. 36,500

4. Ozz Company, a lessor, leased an equipment under an operating lease. The lease term is 5 years and
the lease payments are made in advance on January 1 of each year as shown in the following schedule:
January 1, 2017 1,000,000
January 1, 2018 1,000,000
January 1, 2019 1,400,000
January 1, 2020 1,700,000
January 1, 2021 1,900,000
Total rentals 7,000,000

1. What is the rent income for 2017?

a. 1,000,000
b. 1,400,000
c. 2,000,000
d. 1,500,000

2. On December 31, 2018, what amount should be recognized as accrued rent receivable?
a. 700,000
b. 800,000
c. 400,000
d. 0

5. On January 1, 2020 Corpus Company leased a building to Brill under an operating lease for ten years at
600,000 per year, payable at the first day of each lease year.

Corpus has paid an amount of 250,000 for a real estate broker as a finder’s fee.
The building is depreciated annually for 120,000 aside from this the company has also paid insurance
and property tax expense of 90,000.

What should be the reported net income for 2020?

a. 365,000
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b. 140,000
c. 600,000
d. 455,000

6. On January 1, 2022, an entity leased a building from a lessor with the following pertinent information.
Annual rental payable at the end of each year 1,000,000
Initial direct cost paid 400,000
Lease incentive received 100,000
Leasehold improvement 200,000
Purchase option that is reasonably certain to be exercised 500,000
Lease term 5 years
Useful life of building 8 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
Present value of 1 for 5 periods at 10% 0.62

1. What is the cost of the right of use asset?

a. 4,500,000
b. 4,400,000
c. 4,700,000
d. 4,600,000

2. What is the lease liability on December 31, 2022?

a. 3,510,000
b. 3,169,000
c. 3,950,000
d. 3,719,000

7. At the beginning of the current year, Joshtin Company leased a machinery with the following
information:

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

Residual value guarantee 500,000
Payment to lessor to obtain a long-term lease 300,000
Cost of dismantling and restoring the asset as required
by contract at present value 390,000
Annual executory cost paid by lessee 50,000
Lease term 4 years
Useful life of machinery 8 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 at 10% for 4 periods 3.17
Present value of 1 at 10% for 4 periods 0.68

1. What is the initial lease liability?

a. 3,510,000
b. 3,170,000
c. 4,010,000
d. 4,000,000

2. What is the cost of right use asset?

a. 4,200,000
b. 4,250,000
c. 3,810,000
d. 3,900,000

3. What is the depreciation for current year?

a. 462,500
b. 925,000
c. 850,000
d. 965,000

4. What is the lease liability at year-end?

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a. 2,510,000
b. 3,159,000
c. 2,861,000
d. 3,620,000

8. Jerome Company entered into a ten-year non-cancelable lease requiring year-end payments of
1,200,000 on January 01, 2022. The incremental borrowing rate is 15%, while the lessor’s implicit
interest rate is 10%. Present value factors for an ordinary annuity for ten periods are 6.145 at 10% and
5.019 at 15%. An initial direct cost of P 150,000 in negotiating and securing the leasing arrangement
was paid on the same day. Ownership of the property remains with the lessor at expiration of the lease.
There is no purchase option. The leased property has an estimated economic life of 12 years.

1. What amount should be capitalized initially as cost of the right of use asset?
a. 7,245,000
b. 7,524,000
c. 7,750,000
d. 6,850,000

2. What amount should be recognized initially as lease liability?

a. 7,245,000
b. 6,145,000
c. 7,345,000
d. 7,374,000

3. What is annual depreciation of the right of use asset?

a. 834,500
b. 614,100
c. 752,400
d. 734,500

9. An entity recorded the cost of right use asset at 4,500,000. The underlying asset had a useful life of 8
years and the lease term is 5 years. The asset is expected to have a fair value of 1,500,000 at the end
of 5 years and a fair value of 500,000 at the end of 8 years.

The lease agreement provided for the transfer of title of the underlying asset to the lessee at the end of
the lease term.

What amount of depreciation expense should be recorded for the first year of the lease?
a. 900,000
b. 800,000
c. 600,000
d. 500,000

10. On January 1, 2022, Kaila Company and the lessor agreed to amend the original terms of the lease by
reducing the lease payment to 50,000 and increasing the implicit rate to 9%.

The lease liability has a carrying amount of 200,000 on January 1, 2022.

The present value of an ordinary annuity of 1 at 9% for 3 periods is 2.5313.

What is the decrease or increase in lease liability for 2022?

a. 73,435 increase
b. 73,435 decrease
c. 50,000 increase
d. 50,000 decrease

11. On December 30, year 1, Tricia Corp. leased equipment under a finance lease. Annual lease payments
of 20,000 are due December 31 for ten years. The equipment’s useful life is ten years, and the interest
rate implicit in the lease is 10%. The finance lease obligation was recorded on December 30, year 1, at
135,000, and the first lease payment was made on that date.
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What amount should Tricia include in current liabilities for this finance lease in its December 31, year 1
balance sheet?
a. 6,500
b. 8,500
c. 11,500
d. 20,000

12. On January 2, year 1, Philex Mining Co. (lessee) entered into a five-year lease for drilling equipment.
Philex accounted for the acquisition as a capital lease for 240,000, which includes a 10,000 bargain
purchase option. At the end of the lease, Philex expects to exercise the bargain purchase option. Philex
estimates that the equipment’s fair value will be 20,000 at the end of its eight-year life. Philex regularly
uses straight-line depreciation on similar equipment. For the year ended December 31, year 1, what
amount should Philex recognize as depreciation expense on the leased asset?
a. 48,000
b. 46,000
c. 30,000
d. 27,500

13. Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets the criteria to
be a finance lease for Metcalf. The six-year lease requires payment of 102,000 at the beginning of each
year, including 15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate
for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of
an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six
years at 8% is 4.99271. Metcalf should record the leased asset at
a. 509,256
b. 488,661
c. 434,366
d. 416,799

14. An entity is a dealer in equipment and uses leases to facilitate the sale of its product. The entity expects
a 12% return. At the end of the lease term, the equipment will revert to the lessor.

On January 1, 2022, an equipment is leased to a lessee with the following information:

Cost of equipment to the entity 3,500,000
Fair value of equipment 5,500,000
Residual value – unguaranteed 600,000
Initial direct cost 200,000
Annual rental payable in advance 900,000
Useful life and lease term 8 years
Implicit interest rate 12%
PV of 1 at 12% for 8 periods 0.40
PV of an ordinary annuity of 1 at 12% for 8 periods 4.97
PV of an annuity due of 1 at 12% for 8 periods 5.56
First lease payment January 1, 2022

1. What is the gross investment in the lease?

a. 7,800,000
b. 7,200,000
c. 6,600,000
d. 6,900,000

2. What is the net investment in the lease?

a. 5,004,000
b. 5,244,000
c. 5,500,000
d. 5,740,000

3. What is the total financial revenue?

a. 2,196,000
b. 2,796,000
c. 2,556,000
d. 1,956,000
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4. What amount should be recognized as interest income for 2022?

a. 600,480
b. 492,480
c. 536,760
d. 521,280

5. What amount of cost of goods sold should be recognized in recording the lease?

a. 3,260,000
b. 3,500,000
c. 3,740,000
d. 3,460,000

15. Fernando Incorporated uses leases as a method of selling its products. In early 2021, Fernando
completed construction of a passenger ferry for use between Quiapo and Guadalupe. On April 1, 2021,
the ferry was leased to the Talion Ferry line on a contract specifying that ownership of the ferry will
transfer to the lessee at the end of the lease period. The ferry is expected to be economically useful for
25 years. Annual lease payments do not include executory costs. Other terms of the agreement are as
follows:

Original cost of the ferry P1,500,000

Lease payments P225,000
Estimated residual value P78,000
Implicit rate 10%
Date of first lease payment April 1, 2021
Lease period 20 years
PV of an ordinary annuity of 1 for 20 periods at 10% 8.5136
PV of an annuity due of 1 for 20 periods at 10% 9.3649
PV of 1 for 20 periods at 10% 0.1486

Based on the above and the result of your audit, determine the following.

1. Total finance income that will be earned by the lessor over the lease term
a. 2,459,306 c. 2,392,897
b. 2,650,849 d. 2,584,440

2. The profit on sale to be recognized by the lessor

a. 607,103 c. 415,560
b. 427,151 d. 618,694

3. Liability under finance lease to be reported by the lessee as of December 31, 2022
a. 1,634,616 c. 1,858,063
b. 1,845,313 d. 1,647,366

4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of
December 31, 2022
a. 61,538 c. 40,469
b. 39,194 d. 60,263

5. Depreciation expense to be recognized by the lessee for the year 2021

a. 61,221 c. 76,091
b. 55,127 d. 60,873

16. At the beginning of current year, World Company sold a machine and immediately leased it back. The
following data pertain to the sale and leaseback transaction:

Sale price at fair value 5,000,000

Carrying amount of machine 6,000,000
Annual rental payable at the end of the year 500,000
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Implicit interest rate 6%

Present value of an ordinary annuity of 1 at
6% for 5 periods 4.21

1. What is the initial lease liability?

a. 2,500,000
b. 2,105,000
c. 3,000,000
d. 0

2. What is the cost of right of use asset?

a. 2,105,000
b. 2,526,000
c. 2,895,000
d. 1,500,000

3. What is the loss on right transferred to the buyer-lessor?

a. 508,200
b. 500,000
c. 579,000
d. 0

4. What is the net annual rent income of the buyer-lessor?

a. 373,700
b. 200,000
c. 500,000
d. 250,000

17. At the beginning of current year, Judy Company sold a building with remaining useful life of 30 years
and immediately leased it back for 5 years.

Sale price at below fair value 18,000,000

Fair value of building 20,000,000
Carrying amount of building 24,000,000
Annual rental payable at the end of each year 1,000,000
Implicit interest rate 12%
Present value of an ordinary annuity of 1 at 12%
For 5 periods 3.60

1. What is the initial lease liability?

a. 3,600,000
b. 4,000,000
c. 4,800,000
d. 0

2. What is the cost of right of use of asset?

a. 3,000,000
b. 2,880,000
c. 5,760,000
d. 6,720,000

3. What is the loss on right transferred?

a. 4,000,000
b. 2,880,000
c. 4,320,000
d. 6,000,000

4. What is the net annual rent income of the buyer-lessor?

a. 400,000
b. 200,000
c. 300,000
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d. 100,000

18. Arizcom Company leased an equipment to Jie Co. using the terms of an operating lease. The leased
equipment is a 4-year term made in advance every April 1 with different annual payments as shown
below.
April 1
Year 1 1,300,000
Year 2 1,250,000
Year 3 1,400,000
Year 4 1,000,000

1. What is the Average Annual Rental Income for year 1?

a. 1,237,500
b. 1,000,000
c. 1,300,000
d. 1,347,530

2. What amount should be recognized as accrued rent receivable at December 31 year 2?

a. 237,500
b. 950,000
c. 337,500
d. 50,000

19. At the beginning of the year, Harry Co. sold a machine having a useful life of 15 years and immediately
leased it back for 6 years. The data below pertains to the sales and leaseback transaction.

Sales Price at FV P 8,000,00

Book Value of Machine 6,000,000
Annual Rental payable at the end of each year 750,000
Implicit Interest rate 10%

1. What is the initial lease liability?

a. 2,762,000
b. 3,270,000
c. 3,260,000
d. 2,440,000

2. What is the cost of the right of the use of asset?

a. 3,270,000
b. 3,744,000
c. 3,872,300
d. 2,452,800

3. What is the gain or loss transferred to buyer-lessor?

a. 1,182,600
b. 1,844,000
c. 1,872,500
d. 1,182,303

20. On December 31, 2020, Clean Company sold a machine with a 10-year useful life to another entity and
simultaneously leased it back for one year. The sales price of the machine is 450,000 with a carrying
amount of 400,000. The present value of the reasonable lease rentals is 36,000.

What amount of gain on right transferred should be reported in the current year?
a. 36,000
b. 40,000
c. 50,000
d. 55,000
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21. Joshtin Company’s cost of right of use asset is amounting to 4,200,000. The machinery it leased has a
guarantee residual value of 500,000 and the fair value after the life is 400,000. The machinery has a
useful life of 8 years while the lease term is 4 years.

1. Assuming there is no transfer of title, what will be the amount of depreciation for the current year?
a. 700,000
b. 750,000
c. 800,000
d. 925,000

2. Assuming there is a transfer of title, what will be the amount of depreciation for the current year?
a. 550,000
b. 475,000
c. 800,000
d. 925,000

22. IV of Spades Company sold to Josh Company a building and immediately leased it back. Using the
following information compute for the gain on right transferred to the buyer-lessor: present value of an
ordinary annuity of 1 at 4% for 6 periods 5.24; implicit interest rate 3% (two decimal places); remaining
life of building 15 years; Lease term 6 years; Annual rental payable at the end of each year 600,000;
Carrying amount of the building 7,000,000; Sale price at fair value 90% of the carrying amount.
a. 338,667
b. 388,766
c. 700,000
d. 0

23. Angel Company entered into a finance lease on January 1, 2022. The lessee guaranteed the residual
value of the asset under the lease estimated to be 1,200,000 on January 1, 2027, the end of the lease
term.

Annual lease payments are 1,000,000 due each December 31, beginning December 31,2022.The last
payment is due December 31, 2026.

The remaining useful life of the asset was six years at the commencement of the lease.
Both the lessor and the lessee used 10% as the interest rate. The PV of 1 at 10% for 5 periods is .62,
and the PV of an ordinary annuity of 1 at 10% for 5 periods is. 3.79.

1. What is the net lease receivable of the lessor at the commencement of the lease?
a. 4,534,000
b. 3,790,000
c. 4,990,000
d. 2,590,000

2. What is the gross investment in the lease?

a. 5,000,000
b. 6,200,000
c. 3,800,000
d. 5,744,000

3. What is the total unearned interest income?

a. 2,410,000
b. 1,666,000
c. 1,210,000
d. 466,000

4. What is the interest income for 2022?

a. 379,000
b. 620,000
c. 453,400
d. 500,000
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24. During the year Jerome Company had a cost of right of use amounting to 5,065,000. The lease
agreement showed that there is a cost of restoration at an estimated amount of 250,000, indirect cost of
400,000 and a lease incentive of 300,000.

What amount should be recognized as lease liability?

a. 4,725,000
b. 4,715,000
c. 5,415,000
d. 4,915,000

25. On January 1, 2022, Angel Company entered to a ten-year non-cancelable lease agreement to lease a
building from Oz Company. The agreement required equal annual payments at the end of each year.
The fair value of the building at the beginning of the lease is 3,949,500, while the carrying amount to Oz
Company is 3,458,000. The building has estimated useful life of 10 years. The title of the building will be
transferred to Angel at the end of the lease. The incremental borrowing rate of Angel Company is 12%.
Oz Company set the annual rental to insure 10% rate of return. The implicit rate of the lessor is known
by the lessee. The annual lease payment includes 35,000 executory costs.

1. What is the minimum annual lease payment?

a. 642,718
b. 500,000
c. 562,734
d. 480,000

2. What Is the total annual lease payment?

a. 515,000
b. 535,000
c. 597,734
d. 677,718

26. On January 1, 2021, Catherine Corporation signed a five-year non-cancelable lease for equipment. The
terms of the lease called for Catherine to make annual payments of 50,000 at the beginning of each
year for five years with title to pass to Catherine at the end of this period. The equipment has an
estimated useful life of 7 years and no residual value. Catherine uses the straight-line method of
depreciation for all of its fixed assets. Catherine accordingly accounts for this lease transaction as a
finance lease. The minimum lease payments were determined to have a present value of 208,493 at an
effective interest rate of 10%.

1.In 2021, Catherine should record interest expense of

a. 15,849.
b. 29,151.
c. 20,849.
d. 34,151.

2.In 2022, Catherine should record interest expense of

a. 10,849.
b. 12,434.
c. 15,849.
d. 17,434.

27. Pork and Chop Company leased many assets and capitalized most of the leased assets. On December
31, 2022, the entity had the following balances in relation to a piece of specialized equipment:

Right of use asset 4,000,000

Accumulated depreciation 2,465,000
Lease liability 1,300,000

Depreciation has been recorded up to end of the year, and no accrued interest is involved. On
December 31, 2022, the entity decided to purchase the equipment for 1,600,000 and paid cash to
complete the purchase.

What is the cost of equipment purchased?

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a. 1,835,000
b. 1,935,000
c. 1,093,000
d. 2,424,000

28. At the beginning of the current year, Kaila Company sold an equipment and the n immediately leased it
back. The following data pertain to the sale and leaseback transaction.
Sale price at below fair value 3,950,000
Fair value of the machine 4,350,000
Carrying amount of machine 2,950,000
Annual rental payable at the end of each year 400,000
Lease term 3 yrs.
Implicit rate 5%
PV of ordinary annuity of 1 at 5% 2.72

What is the gain to be recognized on right transferred to the buyer-lessor?

a. 920,123
b. 980,102
c. 921,103
d. 980,600

29. In connection with your audit Shawn Enterprises, you noted that the company has a long-standing policy
of acquiring company equipment by leasing. Early in 2022, the company entered into a lease for a new
milling machine. The lease stipulates that annual payments will be made for 5 years. The payments are
to be made in advance on December 31 of each year. At the end of the 5-year period, Shawn may
purchase the machine. The estimated economic life of the equipment is 12 years. Shawn uses the
calendar year for reporting purposes and straight-line depreciation for other equipment. In addition, the
following information about the lease is also available:

Annual lease payments

(including executory costs of P5,000) P60,000
Purchase option price P25,000
Estimated fair value of machine after 5 years P75,000
Implicit rate 10%
Date of first lease payment Jan. 1, 2022

Based on the foregoing and the result of your audit, compute for the following: (Round off present value
factors to four decimal places.)

1. Amount to be capitalized as an asset for the lease of the milling machine.

a. 229,345
b. 224,017
c. 244,868
d. 275,913

2. Liability under finance lease as of December 31, 2022

a. 130,919
b. 153,855
c. 136,780
d. 189,868

3. Amount to be reported under current liabilities as liability under finance lease as of December 31,
2022
a. 39,614
b. 41,322
c. 41,908
d. 36,013

4. Interest expense for the year 2022

a. 17,435
b. 18,987
c. 16,902
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d. 0

5. Depreciation expense for the year 2022

a. 20,406
b. 19,112
c. 18,668
d. 48,974

30. Talion Inc. leases equipment to its customers under non-cancelable leases. On January 1, 2022, Talion
leased equipment costing 4,000,000 to Herbert Co., for nine years. The rental cost was 440,000
payable in advance semiannually (January 1 and July 1), plus 20,000 semiannually for executory costs.
The equipment had an estimated life of 15 years and sold for 5,330,250 with an estimated unguaranteed
residual value of 800,000. The implicit interest rate is 12 percent.

Based on the foregoing and the result of your audit, compute for the following: (Round off present value
factors to four decimal places.)

1. How much is the total interest income from lease that will be earned by Talion, Inc.?
a. 2,869,988
b. 3,389,748
c. 3,675,616
d. 0

2. Talion, Inc. should report profit on the sale at

a. 1,330,252
b. 1,044,384
c. 1,050,012
d. 1,338,492

3. How much should be reported by Herbert Co. as liability under finance lease as of December 31,
2022?
a. 4,143,593
b. 4,446,613
c. 4,273,410
d. 0

4. How much should be reported by Herbert Co. under current liabilities as liability under finance lease
as of December 31, 2022?
a. 356,798
b. 378,207
c. 394,252
d. 0

5. How much interest expense should be reported by Herbert Co. in relation to the lease for the year
ended December 31, 2022?
a. 508,064
b. 501,793
c. 543,398
d. 0
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