AUDITING PROBLEMS

AUDIT OF LEASE

Submitted by:
Patricio, Chan Nheth S.
Riva, Jocelyn E.
Romualdo, Christine P.
Rosco, Ivan Louise O.
San Buenaventura, Zuesette P.
AC42

Submitted to:
Marcial C. Paglinawan, CPA
September 2018
PROBLEM NO 1. Operating Lease – Comprehensive
On January 1, 2014, Alymark Co. entered into a 4-year nonrenewable operating lease,
commending on that date, for office space. The office space has a useful life of 50 years. The rent
specifies a monthly rent of P30,000.
Questions:
Assume the following independent cases:
Case No 1: Assume that no other data was given
1. How much is the total rent expense in 2014?
a. 330,000 c. 410,000
b. 360,000 d. 307,500
Answer: B
Solution:
Monthly Rent P 30,000
(x) months 12
Total Rent Expense P360,000
Explanation:
PAS 17, paragraph 33, provides that lease payments under an operating lease shall be recognized
as an expense on a straight-line basis over the lease term unless another systematic basis is more
representative of the time pattern of the user’s benefit.
Case No 2: Assume instead that Alymark Co. made the following payments on January 1, 2014:
Bonus to obtain Lease 200,000
One year’s rent 360,000
Last month’s rent 30,000
2. How much is the total rent expense in 2014?
a. 560,000 c. 410,000
b. 590,000 d. 360,000
Answer: C
Solution:
Annual Rent (30,000 x 12) P360,000
Amortization of Lease Bonus (200,000 ÷ 4) 50,000
Total Rent Expense P410,000
Explanation:
PAS 17, paragraph 33, provides that lease payments under an operating lease shall be recognized
as an expense on a straight-line basis over the lease term unless another systematic basis is more
representative of the time pattern of the user’s benefit.
The lease bonus paid by the lessee to the lessor in addition to the periodic rental is treated as
prepaid rent expense by the lessee to be amortized over the lease term.
The last month’s rent is also a prepaid rent. It is not added because it is already included in the
annual rent of 360,000.

PROBLEM NO. 2. Finance Lease with Bargain Purchase Option

On December 31, 2015, Brenet Co. signed a 5 year noncancelable lease for a new machine
requiring P100,000 annual payments beginning December 31, 2015. The machine has a useful
life of 10 years with no salvage value. The rate implicit on the lease is 10%.
Brent has a bargain purchase option amounting to 30,000. It is certain that the company will
exercise the option.
The fair value of the machine at the inception of the leased amounted to P463,422.
Questions:
Based on the above data, answer the following:
1. How much is the amount capitalized as machinery ( leased asset ) on December 31, 2015.
a. 435,617 c. 500,000
b. 587, 247 d. 530,000
Answer: A
Solutions:
Principal value of rentals (100,000 x 4.17017) P417,617
Present value of bargain purchase option (30000 x .620) 18,627
Lease Liability- December 31, 2015 P435,617

2. How much is the interest expense in 2016?

a. Nil c. 50,000
b. 33, 562 d. 53,000
Answer: B
Solutions:
Principal value of rentals (100,000 x 4.17017) P 417,617
Present value of bargain purchase option (30000 x .620) 18,627
Lease Liability- December 31, 2015 P435,617
Less: First Payment 100,000
Lease Liability P335,617
Less: Second Payment- December 31, 2016
Payment 100,000
Interest (10% x 335,617) 33,562
Principal (Current Portion) 66438
Lease Liability- December 31, 2016 P269,179

3. How much is the leased-related liability to be shown as current in the statement of financial
position on December 31, 2015?
a. 335,617 c. 66,438
b. 269, 179 d. 33,562
Answer: C
Solutions:
Current Portion P66,438
(represented by the principal on December 31, 2016 )

4. How much is the leased-related liability to be shown as non-current in the statement of

financial position on December 31, 2015?
a. 335,617 c. 66,438
b. 269, 179 d. 33,562
Answer: B
Solution:
Non-Current Portion 269,179
Explanation:
For a finance lease, the lessee should recognize an asset and liability. The cost of the asset and
initial liability should be the lower of the fair value of the asset or the present value of minimum
lease payments. So, the total cost of the machinery is P435, 617 since it is lower than the fair
value of P463,422.
PAS 17, Paragraph 4, provides if the lessee has an option to purchase the asset at a price
that is expected to be sufficiently lower than fair value at the date the option becomes
exercisable for it to be reasonably certain, at the inception of the lease, that the option will
be exercised, the minimum lease payments comprise the minimum payments payable over
the lease term to the expected date of exercise of this purchase option and the payment
required to exercise it.

Case No. 3: Assume instead that the lessor grants free rent of 7 months
3. How much is the total rent expense in 2014?
a. 330,000 c. 410,000
b. 360,000 d. 307,500
Answer: D
Solution:
Lease Term (4 Years) 48 months
Less: Rent-free months 7 months
Number of Lease Payments 41 months
x Monthly Rental P 30,000
Total Rents P1,230,000
÷ Lease Term 4
Annual Rent Expense P 307,500
Explanation:
If the lease agreement provides for a rent-free months or holiday, the total cash rental must be
determined and amortized on a straight-line basis (over the lease term of 4 years) unless another
systematic and rational basis is more appropriate (PAS 17, par 33).
4. How much is the prepaid rent (or accrued rent payable) on December 31, 2015?
a. Nil c. (60,000)
b. (105,000) d. (150,000)
Answer: B
Solution:
Rent Expense for two years (307,500 x 2) P615,000
Payment for two years (30,000 x 24) (720,000)
Accrued Rent Payable (105,000)
Explanation:
The difference between the rent expense (lessee) or rent income (lessor) over the cash paid (lessee)
or cash received (lessor) is either a prepaid or accrued rent (lessee) or either an accrued or unearned
income (lessor).
Case No 4: Assume instead the rent payment will be as follows:
Rent per month for the first two years 25,000
Rent per month for the last two years 30,000
5. How much is the total rent expense in 2014?
a. 330,000 c. 410,000
b. 360,000 d. 307,500
Answer: A
Solution:
Rent for the first two years (25,000 x 24 months) P600,000
Rent for the last two years (30,000 x 24 months) 720,000
Total Cash Rent P1,320,000
÷ Lease Term 4
Annual Rental Expense P 330,000
Explanation:
If the operating lease agreement provides for varying periodic rentals, rent expense/income should
be recognized on a straight-line basis unless a systematic and rational basis is more appropriate,
meaning, the total cash rental throughout the duration of the lease contract must be determined and
amortized over the lease term. (see PAS 17 par 33 & 50)
6. How much is the prepaid rent (or accrued rent payable) on December 31, 2015?
a. Nil c. (60,000)
b. (105,000) d. (150,000)
Answer: C
Solution:
Rent Expense for two years (330,000 x 2) P660,000
Payment for two years (30,000 x 24) (720,000)
Accrued Rent Payable P(60,000)
Explanation:
The difference between the rent expense (lessee) or rent income (lessor) over the cash paid (lessee)
or cash received (lessor) is either a prepaid or accrued rent (lessee) or either an accrued or unearned
income (lessor).
Case No 5: Assume instead that the lessor paid the following:
Initial Direct Cost 60,000
Insurance and property tax expense 30,000
Depreciation of the leased asset 30,000
7. How much is the net income to be recognized as a result of this lease in 2014?
a. 285,000 c. 240,000
b. 360,000 d. 300,000
Answer: A
Solution:
Annual Rent Income (30,000 x 12) P360,000
Amortization of Initial Direct Cost (60,000 ÷ 4) (15,000)
Insurance and property tax expense (30,000)
Depreciation of the leased asset (30,000)
Net Income P285,000
Explanation:
PAS 17, paragraph 52, provides that initial direct cost incurred by the lessor shall be added to the
carrying amount of the asset and recognized as expense over the lease term on the same basis as
lease income.
Case No 6: Assume that in addition to the monthly rent, the lessor and lessee agreed on the
following additional rent:
Rate Net Sale Over Up to
8% 1,000,000 3,000,000
5% 3,000,000
The total net sales for 2014 were 6,000,000.
8. How much is the total rent expense in 2014?
a. 670,000 c. 510,000
b. 520,000 d. 360,00
Answer: A

Solution:
Annual Rental (30,000 x 12) P360,000
Additional Rental *310,000
Total Rent Expense P670,000

*Additional Rental
Net Sale over 1M up to 3M (2,000,000 x 8%) P160,000
Net Sale over 3M (3,000,000 x 5%) 150,000
Total P310,000
Explanation:
Periodic rentals is recognized as an expense, any contingent rentals, which are based on company
sales, should be expensed in the period they relate.
PROBLEM NO. 3. With Guaranteed Residual Value and Initial Direct Cost
On December 31, 2015, Kasibu Co. signed a 4-year, non-cancelable lease for a new machine
requiring P130,000 annual payments beginning December 31, 2015. The annual payments
include payment for insurance and property taxes amounting to P10,000. On the same date,
Kasibu Co. paid incremental costs that are directly attributable to negotiating and arranging a
lease. The machine has a useful life of 10 years, with no residual value. The rate implicit on the
lease is 10%.
Kasibu Co. guarantees a residual value of P30,000 at the end of the lease term. The fair value of
the machine at the inception of the lease amounted to P466,934.
Questions:
Case 1: Based on the above data, answer the following:
1. How much is the amount to be capitalized as machinery (leased asset) on December 31,
2015?
a. 438,918 c. 458,918
b. 495,975 d. 488,918
Answer: C

Solution:

Present value of an ordinary annuity of 1 at 10% for 4 periods 2.48685

Present Value of 1 at 10% for 4 periods 0.68301
Annual Payment
Advance payment 130,000
PV of rentals (130,000x2.48685) 323,290 P453,290
Less: Property Taxes
1st annual payment 10,000
PV of Insurance and property taxes 24,868 (34,868)
(10,000x2.48685)
Lease Liability-December 31,2015 P418,422
Indirect Cost 20,000
Present Value of Guaranteed Residual Value (30,0000x0.68301) 20,490
Minimum Lease Payment P458,918

Explanation:
For a finance lease, the lessee should recognize an asset and liability. The cost of the asset and
initial liability should be the lower of the fair value of the asset or the present value of minimum
lease payments. So, the total cost of the machinery is P458,918 since it is lower than the fair
value of P466,934.

2. How much is the interest expense in 2016?

a. Nil c. 45,892
b. 31,892 d. 48,892

Answer: B
Solution:

Date Payment Interest Principal Present Value

12/31/15 458,918
12/31/15 130,000 - 130,000 328,918
12/31/16 130,000 31,892 98,108 230,810
12/31/17 130,000 23,081 106,919 123,891
12/31/18 130,000 12,389 117,611 6,280
12/31/19 130,000 23,720 6,280 -

Interest (2016) = 318, 918x10% = P31, 912

3. How much is the lease-related liability to be shown as current in the statement of

financial position on December 31, 2015?
a. 318,918 c. 88,108
b. 230,810 d. 31,892

Answer: C
Solution:
Annual Rental P130,000
Less: Interest Expense -2015
Total Liabilities,net of tax (12/31/15) P448,918
Less: Annual Payment 130,000
Total Liabilities (12/31/15) 318,918
X Effective Interest Rate 10% (31,892)
Current Portion P88,108
 4. How much is the lease-related liability to be shown as noncurrent in the statement of
financial position on December 31, 2015?
a. 318,918 c. 88,108
b. 230,810 d. 31,892
Answer: B

Solution:
Carrying Amount(12/31/15) P328,918
Less: Principal Amount
Annual Payment P130,000
Interest Expense (31,892) 98,108
Carrying Amount (Non-current Portion) P230,810

Explanation:
PAS 17, par 23: “It is not appropriate for liabilities for leased assets to be presented in the
financial statements as a deduction from leased assets. If for the presentation of liabilities on the
face of the balance sheet a distinction is made between current and non-current liabilities, the
same distinction is made for lease liabilities.”

Case 2: Assume instead that the fair value of the machine at the inception of lease amounted to
P430,122:
5. How much is the amount to be capitalized as machinery (leased asset) on December 31,
2015?
a. 438,918 c. 458,918
b. 430,122 d. 450,122
Answer: D

Solution:
Fair Value P430,122
Direct Cost 20,000
Net investment in the lease P450,122

Explanation:
Since the net investment in the lease is lesser than the minimum lease payment of P458,918, the
total cost of the leased machine is P450,122.
6. How much is the interest expense in 2016?
a. Nil c. 52,776
b. 31,892 d. 35,664
Answer: D
Solution:
Interest Expense P310,122x11.5%= P35,664
 7. How much is the lease-related liability to be shown as current in the statement of
financial position on December 31, 2015?
a. 84,336 c. 310,122
b. 88,108 d. 225,786
Answer: A
Solutions:
Annual Rental P130,000
Less: Interest Expense -2015
Total Liabilities,net of tax (12/31/15) P450,122
Less: Annual Payment 130,000
Total Liabilities (12/31/15) 310,122
X Effective Interest Rate 11.5% (35,664)
Current Portion P84,336

8. How much is the lease-related liability to be shown as noncurrent in the statement of

financial position on December 31, 2015?
a. 84,336
b. 88,108
c. 310,122
d. 225,786
Answer: D
Solution:
New implicit rate: 11.50% (calculated through interpolation)
Date Payment Interest Principal Present Value
12/31/15 P450,122

12/31/15 130,000 - 130,000 310,122

12/31/16 130,000 35,664 84,336 225,786

Carrying Amount (12/31/15) P310,122

Less: Principal Amount 130,000
Interest Expense 35,664 84,336
Noncurrent Portion P225,786

Explanation:

PAS 17, par 23: “It is not appropriate for liabilities for leased assets to be presented in the
financial statements as a deduction from leased assets. If for the presentation of liabilities on the
face of the balance sheet a distinction is made between current and non-current liabilities, the
same distinction is made for lease liabilities.”

PAS 17, par 38: “Initial direct costs are often incurred by lessors and include amounts such as
commissions, legal fees and internal costs that are incremental and directly attributable to
negotiating and arranging a lease. For finance leases other than those involving manufacturer or
dealer lessors, initial direct costs are included in the initial measurement of the finance lease
receivable and reduce the amount of income recognised over the lease term. The interest rate
implicit in the lease is defined in such a way that the initial direct costs are included
automatically in the finance lease receivable; there is no need to add them separately. Costs
incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease
are excluded from the definition of initial direct costs. As a result, they are excluded from the net
investment in the lease and are recognised as an expense when the selling profit is recognised,
which for a finance lease is normally at the commencement of the lease term.”

The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to
pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the
lessee would incur to borrow over a similar term, and with a similar security, the funds necessary
to purchase the asset.

PROBLEM NO. 4. Finance Lease – Depreciation

On December 31, 2014, Bakun Co. signed a 4-year noncancelable finance lease for a new machine
for P438,918. The machine has a useful life of 10 years. Bakun regularly uses straight line
depreciation on similar asset.
Assume that the cost of the machine includes P30,000 gross bargain purchase option.
Questions:
Based on the above data, answer the following:
Case No 1: At the end of the lease, Bakun expects to exercise the bargain purchase option. Bakun
estimates that the equipment’s fair value will be P50,000 at the end of its useful life.
1. How much is the depreciation expense on December 31, 2015?
a. 38,892 c. 41,843
b. 102,230 d. 97,230
Answer: A
Solution:
Cost of Leased Equipment P438,918
Less: Estimated Fair Value/Salvage Value 50,000
Depreciable Cost P388,918
÷ Useful Life of the Asset 10
Depreciation Expense P 38,892
Explanation:
Depreciation on Leased Assets will depend on how the lease qualifies as a finance lease:
a. If the lease transaction met the criterion as either transferring ownership or containing a bargain
purchase option. The asset is deprecated over the estimated useful life of the asset.
b. If the transaction qualifies as finance lease because it met either the major part of useful life
criterion or because the present value of minimum lease payments represented substantially all of
the fair value of the underlying asset, it must be depreciated over the lease term or llife of the asset,
whichever is shorter.
The Finance Lease Transaction met the Bargain Purchase Criterion; hence depreciation is based
on the useful life of the Asset.
Case No 2: Assume instead that the cost of the machine include P30,000 gross guaranteed residual
value.
2. How much is the depreciation expense on December 31, 2015?
a. 38,892 c. 41,843
b. 102,230 d. 97,230
Answer: B
Solution:
Cost of Leased Equipment P438,918
Less: Guaranteed Residual Value 30,000
Depreciable Cost P408,918
÷ Lease Term 4
Depreciation Expense P102,230
Explanation:
The guaranteed Residual Value is deducted from cost in determining depreciable amount because
the machine will revert back to the lessor upon the lease expiration.
The lease term of 4 years is used in computing depreciation because there is no bargain purchase
option and no transfer of title.
PROBLEM NO.5. Computation of Periodic Lease Payments
On January 1, 2015, Benguet Co. leased an asset with a fair value of P4,000,000 from Viscaya
Co. for a lease term of 4 years. The lease specifies equal annual payments beginning on January
1, 2015. The lease gurantees a P1,500,000 residual value of the asset the end of the lease term.
The rate implicit on the lease is 10%.
How much is the annual lease payment?
a. 938,673 c. 823,949
b. 853,337 d. 906,347
Answer: B
Solution:
Cost P4,000,000
PV of Residual Value (1,500,000x0.68301) (1,024,520)
Net Investment to be recovered from rentals P2,975,479
Divided by: PV of annuity due of 1 at 10% for 4 periods ÷ 3.4869
Annual Rentals P 853,337

Explanation:

Annual Rental is derived from deducting the Present Value of Residual Value from the Cost of
the leased property and dividing the difference by its PV factor.

PROBLEM NO. 6. Finance Lease (Lessor)

On December 31, 2015, San Carlos Co. leased an equipment with a cost of P4,000,000 to
Urdaneta Co. for 5 years which is also the useful life of the asset. The lease agreement specifies
equal annual payment of P914,585 beginning on December 31, 2015.
At the end of the lease term, the equipment will revert to Carlos Co. A third parted related to the
lease guarantees residual value of the equipment amounting to P300,000. The rate implicit on the
lease is 10%.
Questions:
Based on the above data, answer the following.
1. How much is the total interest income to be earned over the leased term?
a. 827,927 c. 272, 927
b. 572,927 d. 1,172,927
Answer: A
2. How much is the interest expense in 2016?
a. 308,541 c. 247,937
b. 400,000 d. 109,216
Answer: A
3. How much is the leased-related asset to be shown as current in the statement of financial
position on December 31, 2015?
a. 3.085,415 c. 2,479,370
b. 606,044 d. 4,000,000
Answer: B
Solution:

Date Payment Interest Principal Present Value

4000000
12/31/2015 914585 0 914585 3085415
12/31/2016 914585 308541 606044 2479371
12/31/2017 914585 247930 666645 1812720
12/31/2018 914585 181254 733331 1079400
12/31/2019 914585 107930 806655 272728
12/31/2020 300000 27272 272728 0
872927
Explanation:
The annual rental is payable in advance on December 31 of each year starting December 31,
2015.
Since the residual value is guaranteed, the machinery will revert to the lessor at the end of the
lease term.
Interest is equal to the preceding present value times the interest rate. The first rental payment on
December 31, 2015 pertains to principal only.
Thus on December 31, 2016, the interest is equal to 3085415 times 10% or 308541. This interest
income pertains to 2016.
Principal is the portion of the rental payment minus the interest. Thus, on December 31, 2016,
914585 minus 308,541 equals to 606,044 which is the leased-related asset to be shown as
current in the statement of financial position on December 31, 2015.
The present value is the balance of the present value minus the principal. Thus on December 31,
2016, 3,085,415 minus 606,044 equals 2,479,371.
PAS 17, Paragraph 4, Guaranteed residual value for a lessor, that part of the residual value that is
guaranteed by the lessee or by a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.

PROBLEM NO. 7. Direct Financing Lease-With Initial Direct Cost

On December 31, 2015, Dagupan Co. leased an equipment with a cost of P4,000,000 to Josiah
Co. for 5 years which is also the useful life of the asset. The lease agreement specifies equal
annual payment of P959,256 beginning on December 31, 2015. On the same date, Dagupan Co.
paid P66,956 incremental cost that are directly attributable to negotiating and arranging a lease.
At the end of the lease term, the equipment will revert to Dagupan Co.
The rate implicit on the lease is 10% but after considering the initial direct cost the implicit rate
is adjusted at 9%.
Questions:
Based on the above data, answer the following.
1. How much is the total interest income to be earned over the leased term?
a.729,322 c. 1,208,975
b. 796, 278 d. 1,275,931
Answer: A
2. How much is the interest expense in 2016?
a. 304,074 c. 238,556
b. 400,000 d. 279,693
Answer: D
3. How much is the leased-related asset to be shown as current in the statement of financial
position on December 31, 2015?
a. 3,040, 744 c. 2,385, 563
b. 655, 181 d. 679,563
Answer: D
Solutions:

Date Payment Interest Principal Present Value

4066956
12/31/2015 959256 0 959256 3107700
12/31/2016 959256 279693 679563 2428137
12/31/2017 959256 218540 740716 1687421
12/31/2018 959256 151880 807376 880047
12/31/2019 959256 79209 880047 0
729322
Explanation:
The annual rental is payable in advance on December 31 of each year starting December 31,
2015.
Interest is equal to the preceding present value times the interest rate. The first rental payment on
December 31, 2015 pertains to principal only.
Thus on December 31, 2016, the interest is equal to 3,107,700 times 9% or 279,693. This
interest income pertains to 2016.
Principal is the portion of the rental payment minus the interest. Thus, on December 31, 2016,
959,256 minus 279,693 equals to 679,563 which is the leased-related asset to be shown as
current in the statement of financial position on December 31, 2015.
The present value is the balance of the present value minus the principal. Thus on December 31,
2016, 3,107,700 minus 679,563 equals 2,428,137
PAS 17, Paragraph 38 provides that initial direct costs are often incurred by lessors and include
amounts such as commissions, legal fees and internal costs that are incremental and directly
attributable to negotiating and arranging a lease.. The interest rate implicit in the lease is defined
in such a way that the initial direct costs are included automatically in the finance lease
receivable; there is no need to add them separately. Costs incurred by manufacturer or dealer
lessors in connection with negotiating and arranging a lease are excluded from the definition of
initial direct costs. As a result, they are excluded from the net investment in the lease and are
recognised as an expense when the selling profit is recognised, which for a finance lease is
normally at the commencement of the lease term.

PROBLEM NO. 8.
WASTED TIME, a dealer of machinery and equipment entered as a lessor on the following lease:
First Lease
On January 1, 2006, a machinery was leased to another enterprise with the following provisions:
Annual rental payable at the end of each year 3,000,000
Lease term and useful of machinery 5 years
Cost of machinery 8,000,000
Residual value- unguaranteed 1,000,000
Implicit interest rate 12%
PV of an ordinary annuity of 1 for 5 periods at 12% 3.60
PV of 1 for 5 periods at 12% 0.57

At the end of the lease term on December 31,2010, the machinery will revert to WASTED TIME.
The perpetual inventory system is used. WASTED TIME incurred initial direct cost of P300,000
in finalizing the lease agreement. The lease is appropriately recorded as sales type lease.
Second Lease
TEQUILA SUNRISE Company leased equipment from WASTED TIME Co on July 1,2006 for
an eight-year period expiring June 30, 2013. Equal payments under the lease are P1,200,000 and
are due on July 1 of each year. The first payment was made on July 1,2006. The rate of interest
contemplated by TEQUILA SUNRISE and WASTED TIME is 10%. The cash selling price of the
equipment is P7,040,000 and the cost of the equipment on WASTED TIME’s accounting records
is P5,600,000. The lease is appropriately recorded as sales type lease.
Questions:
Based on the above and the result of your audit, determine the following:
 1. The total financial revenue on the first lease?
a. 4,630,000 c. 5,200,000
b. 4,200,000 d. 3,630,000
Answer: A
Solutions:
Gross rentals (P 3,000,000 x 5) P 15,000,000
Unguaranteed residual value (URV) 1,000,000
Gross Investment P 16,000,000

PV of Gross rentals (P 3,000,000 x 3.6) P 10,800,000

PV of URV (P 1,000,000 x 0.57) 570,000
Net investment P 11,370,000

Unearned Interest Income P 4,630,000

Explanation:

In reference to PAS 17, paragraph 4,the unearned finance income is the difference between:

(a) the gross investment in the lease which is the aggregate of:
o the minimum lease payments receivable by the lessor under a finance lease, and
o any unguaranteed residual value accruing to the lessor, and
(b) the net investment in the lease which is the gross investment in the lease discounted at the
interest rate implicit in the lease

Unguaranteed residual value is that portion of the residual value of the leased asset, the realization
of which by the lessor is not assured or is guaranteed solely by a party related to the lessor.If there
has been a reduction in the estimated unguaranteed residual value, the incomeallocation over the
lease term is revised and any reduction in respect of amounts accrued is recognized immediately.

2. The profit on sale in 2006 on the first lease

a. 7,700,000 c. 2,500,000
b. 3,070,000 d. 3,370,000
Answer: B
Solution:

Sales P 11,370,000
PV of URV 570,000
P 10,800,000
Cost of Machinery 8,000,000
PV of URV 570,000
(7,430,000)
Initial Direct Cost (300,000)
 Gross Profit P 3,070,000

Explanation:

In reference to PAS 17, paragraph 44, the sales revenue recognized at the commencement of the
lease term by dealer lessor is thefair value of the asset, or, if lower, the present value of the
minimum lease payments accruing to the lessor, computed at a market rate of interest or simply
the net investment. The cost of sale recognized at the commencement of the lease term is the cost,
or carrying amount if different, of the leased property less the present value of the unguaranteed
residual value.

The difference between the sales revenue and the cost of sale is the selling profit.

3. The earned financial revenue or interest income for 2006 on the first lease
a. 1,364,400 c. 1,800,000
b. 1,296,000 d. 926,000
Answer: A
Solution:
PV 1/1/06 P 11,370,000
Interest x 12%
Interest Income P 1, 364,400

4. The profit on sale for the year 2006 on the second lease
a. 720,000 c. 90,000
b. 1,440,000 d. 45,000
Answer: B
Solution:
Sales (P 1,200,000 x 5.8685*) P 7,042,200
Cost of Equipment 5,600,000
Profit P 1,442,200

* PV of Annuity Due

5. The interest revenue for the year 2006 on the second lease
a. 292,000 c.176,000
b. 352,000 d.146,000
Answer:A
Solution:
PV 7/1/06 P 7,042,200
1st Rental payment (1,200,000)
Balance 5, 842,400
 Interest (July to December, 6/12 x 12%) x 0.06
Interest revenue P 292,120

PROBLEM NO.9. Sale and Leaseback as Finance Lease

a. The following data relate to a sale and leaseback of equipment of TimMalna Co.
December 31, 2015:
Sales Price 2,162,880
Cost of Equipment 2,000,000
Accumulated Depreciation 100,000
Annual Rent Payable 600,000
Estimated Remaining Life 5
Lease term 5
Implicit rate 12%
What amount of gain on the sale should TimMalna Co. recognized immediately as of December
31, 2015?
a. Nil c. 162,880
b. 262,880 d. 837,120

Answer: A
Explanation:

The answer is 0. The sale and leaseback is a finance lease. It meets the criterion that lease
term is for a major part of the economic life of the asset.

PAS 17, par 50.: If a sale and a leaseback transactions result in finance lease, any excess
of sales proceeds over the carrying amount should not be immediately recognized as
income in the financial statements of a seller-lessee. Instead, it is being deferred and
amortized over the lease term.

Problem No. 10. Sale and Leaseback as Operating Lease – Treatment of Gain
The following data relate to a sale and leaseback of equipment of TimMakder Co. on
December 31,2015:
Sales Price 1,400,000
Cost of equipment 1,800,000
Accumulated depreciation 800,000
Annual rent payable 40,000
Estimated remaining life 8
Lease term 4

Questions:
Based on the above data, answer the following:
 1. Assuming that the fair value amounted to P1,400,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil c. 300,000
b. 400,000 d. 100,000
Answer: B
Solution:
FV P 1,400,000
CA (1,000,000)
Gain P 400,000
Explanation:
In reference to PAS 17, paragraph 61, if the leaseback is an operating lease, and the lease
payments and the sale price are at fair value, there has in effect been a normal sale
transaction and any profit or loss is recognized immediately.

The transaction is established at fair value when the fair value and selling price are equal.

2. Assuming that the fair value amounted to P1,500,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil c. 300,000
b. 400,000 d. 100,000
Answer: B.400,000
SP P 1,400,000
CA (1,000,000)
Gain P 400,000
In reference to PAS 17, paragraph 61, if the sale price is below fair value, any profit or loss
shall be recognizedimmediately; and if the sale price is below fair value but the fair value
is above the carrying amount, the excess of fair value over the carrying amount (P 100,000)
is not recognized.

3. Assuming that the fair value amounted to P1,100,000, what amount of gain on the
sale should TimMakder Co recognized immediately as of December 31,2015?
a. Nil c. 300,000
b. 400,000 d. 100,000
Answer: D.100,000
FV P 1,100,000
CA (1,000,000)
Gain P 100,000
In reference to PAS 17, paragraph 61, if the sale price is above fair value, the excess over
fair value shall be deferred and amortized over the period for which the asset is expected
to be used.
The difference of the fair value and selling price of P 300,000 is a deferred gain that is to
be amortized in proportion to lease payments.

Problem No. 11. Sale and Leaseback as Operating Lease – Treatment of Loss
The following data relate to a sale and leaseback of equipment of TimMackey Co. on
December 31, 2015:
Sales Price 900,000
Cost of equipment 1,800,000
Accumulated depreciation 800,000
Annual rent payable 40,000
Estimated remaining life 8
Lease term 4

Questions:
Based on the above data, answer the following:
1. Assume that the fair value amounted to P900,000, what amount of loss on the sale
should TimMackey Co recognized immediately as of December 31,2015?
a. Nil c. (200,000)
b. (100,000) d. (150,000)
Answer: B
Solution:
FV P 900,000
CA (1,000,000)
Loss (P 100,000)

Explanation:

In reference to PAS 17, paragraph 63, for operating leases, if the fair value at the time of a
sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to
the amount of the difference between the carrying amount and fair value shall be
recognized immediately.

2. Assume that the fair value amounted to P1,000,000, what amount of loss on the
sale should TimMackey Co recognized immediately as of December 31,2015?
a. Nil c. (200,000)
b. (100,000) d. (150,000)
Answer: B. (100,000)
SP P 900,000
CA (1,000,000)
Loss (P 100,000)

In reference to PAS 17, paragraph 61, if the sale price is below fair value, any profit or
loss shall be recognized immediately.

3. Assume that the fair value amounted to P1,000,000 and any loss will be
compensated by below-market future rentals, what amount of loss on the sale
should TimMackey Co recognized immediately as of December 31,2015?
a. Nil c. (200,000)
b. (100,000) d. (150,000)
Answer: A
Solution:
SP P 900,000
CA (1,000,000)
Deferred Loss (P 100,000)

Explanation:

In reference with to PAS 17, paragraph 61, if the sale price is below fair value, any profit
or loss shall be recognized immediately except that, if the loss is compensated for by future
lease payments at below market price, it shall be deferred and amortized in proportion to
the lease payments over the period for which the asset is expected to be used.

No immediate loss. The P 100,000 deferred loss will be amortized in proportion to lease
payments.

PROBLEM NO. 12.

You were engaged in the annual examination of the financial statements of TimMalna
Co. As part of your Audit, you are assigned for the lease and its related account. The
following accounts appear in the ledger:

Building (Leased Asset)

1/1/2015 1,351,805 1,351,805 12/31/2015
 Lease Liability
12/31/2015 84,419 1,351,805 1/1/2015
Bal. End, 12/31/2015 1,066,986

Interest Expense
Bal. End
12/31/2015 115,181 115,181 12/31/2015

Depreciation Expense
Bal. End
12/31/2015 135,181 135,181 12/31/2015

Additional Information:
• The January 1, 2015 balance reflects the amount capitalized on December 31,
2014 when TimMalna Co. leased a building from TimDuncan Co. for a lease term
of 10 years. The building has a useful life of 20 years. There is no transfer of
ownership at the end of the leased asset’s useful life and the fair value of the
building on December 31, 2014 was p 2,000,000. TimMalna Co’s incremental
borrowing rate is 10%. Lease payment of P200,000 is due every December 31,
starting December 31, 2014.
• The beginning balance of the lease liability reflects the amount that was
capitalized on December 31, 2014 less the first payment made on that date.
• The debit entries on December 31, 2015 in the leased liability and interest
expense reflected the amount paid on that date.
• Depreciation expense was also recorded using straight line method.
Questions:
Based on the above data, answer the following:
Case No. 1 : Assume no other data are given, answer the following:
1. How much is the amount to be capitalized as building (leased asset) on December 31,
2014?
a. Nil c. 2,000,000
b. 1,351,805 d. 1,551,805
Answer: A
Explanation:
The lease is an operating lease since there is no transfer of ownership at the end of the
term. Hence, operating lease expenses the lease payments immediately, a capitalized
lease delays recognition of the expense.
PAS 17, paragraph 33, provides that “lease payments under an operating lease shall be
recognized as an expense on straight line basis over the lease term unless another
systematic basis is representative of the time pattern of the user’s benefit”
2. How much is the total lease related expenses in 2015?
a. 290,361 c. 580,000
b. 200,000 d. 250,362
Answer: B
Explanation:
PAS 17, paragraph 33 and 50, provides that the total rentals in an operating lease shall be
recognized by the lessor and lessee as an expense on a straight line basis over the lease
term unless another systematic basis representative of the time pattern of the user’s
benefit.
3. How much is the current liabilities as of December 31, 2015?
a. Nil c. 93,301
b. 200,000 d. 49,638
Answer: A
4. How much is the total leased related liabilities as of December 31, 2015?
a. Nil c. 71,301
b. 1,066,986 d. 1,215,685
Answer: A
For number 3 and 4. There will be no liability recognisesd since the lease is under operating
lease.
According to PAS 17, paragraph 20 " Initial recognition for finance lease, At the
commencement of the lease term, lesses shall recognise finance leases as assets and
liabilities in their statements of financial position at amounts equal to the fair value of the
leased property or, if lower, the present value of the minimum lease payments, each
determined at the inception of the lease. the discount rate to be used in calculating the
present value of the minumun lease payments is the interest rate implicit in the lease, if this
is practicable to determine; if not, the lessee's incremental borrowing rate shall be used.
any initial direct costs of the lessee are added to the amount recognised as an asset."

Case 2 Assume instead that the fair value of the asset is P 1,500,000.
1. How much is the amount to be capitalized as building (leased asset) on December 31,
2014?
a. Nil c. 2,000,000
b. 1,351,805 d. 1,551,805

Answer: B
Solution:
to get ordinary annuity in advance:
1-(1+R)-n X 1 + R
R
1-(1.10)-10 X 1.10
10
= 6.1446 X 1.10
= 6.7590

Present Value of rental payments ( 6.7590 X P200,000) = 1,351, 805

Explanation:
According to PAS 17, paragraph 20 " Initial recognition for finance lease, At the
commencement of the lease term, lesses shall recognise finance leases as assets and
liabilities in their statements of financial position at amounts equal to the fair value of the
leased property or, if lower, the present value of the minimum lease payments, each
determined at the inception of the lease. the discount rate to be used in calculating the
present value of the minimum lease payments is the interest rate implicit in the lease, if this
 is practicable to determine; if not, the lessee's incremental borrowing rate shall be used.
any initial direct costs of the lessee are added to the amount recognised as an asset."
2. How much is the total lease related expenses in 2015?
a. 290,361 c. 580,000
b. 200,000 d. 250,362

Answer: D
Solution:
Depreciation Expense P 135,181.00
Interest Expense 115,181.00
Total Expenses 250, 362.00

3. How much is the current liabilities as of December 31, 2015?

a. Nil c. 93,301
b. 200,000 d. 49,638
Answer: C
Solution:
Principal payment on 12/31/15
Total payment in 2015 P 200,000
Less: Applicable to interest 106,699
(1,066,986 X 10%) 93,301

4. How much is the total leased related liabilities as of December 31, 2015?
a. Nil c. 71,301
b. 1,066,986 d. 1,215,685
Answer: B
Solution:

Interest Interest Applicable to Carrying Amount

income Expense Capital
1/1/2015 200,000 115,181 84,819 1,151,805
12/31/2015 1,066,986