LEASES |1

LEASES (IFRS 16)

- A contract or part of a contract that conveys the right to control the use of an asset, the underlying asset, for a
period of time in exchange of a consideration.
- LESSEE – user of a leased asset
- LESSOR – owner or supplier of a leased asset

IAS 17 vs IFRS 16

- IAS 17: Accounts for operating lease and finance lease

- Operating lease:
- Finance lease:

- IFRS 16: Removes the distinction between finance and operating lease (lessee’s POV only) thus Finance and
Operating Lease are accounted the same way in the lesee’s book. But on the lessor’s book, the accounting in IAS
17 still applies; wherein, finance and operating lease are still accounted differently.
- EXCEPTION: Low-value assets and Short-term leases. Account for lease payments as an expense on a straight-
line basis over the lease term for the following two types of lease:
- SHORT TERM LEASES – where the lease term is at most 12 months; applied to a particular class of assets
- LOW VALUE LEASES – underlying asset has a low value when new; applied on a lease by lease basis.

LESSOR’S BOOK

A. Finance Lease
- In substance, if the risks and rewards over the underlying asset are transferred to the lessee
- the lease is either a sales type lease (STL) or direct financing lease (DFL)

Lease Payments
Reasonable Certain Purchase Option
Residual Value (Guaranteed or Unguaranteed)
GROSS INVESTMENT

PV of the Gross Investment or Cost of the Asset + Initial Direct

Cost Capitalized (if DFL)
NET INVESTMENT*

*The Carrying Amount of the Lease Receivable is equal to the PV or the net investment

Gross Investment
(Net Investment)
TOTAL FINANCIAL REVENUE

Fair Value of Lease Payments

Reasonable Certain Purchase Option
Residual Value Guarantee
OR
Present Value of Lease Payment
Present Value of Reasonable Certain Purchase Option
Present Value of Residual Value Guarantee
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SALES

Cost of the Asset

Initial Direct Cost
(Present Value of Unguaranteed Residual Value)
COST OF SALES

Sales
Cost of Sales
SELLING PROFIT*

*Selling Profit is recognized in full the period of sale.

B. Operating Lease
- In substance, if the risks and rewards over the underlying asset remain with the lessor

LESEE’S BOOK

- All leases are accounted as finance lease (except short-term leases and low value leases)
- RIGHT OF USE ASSET – an asset that represents the lessee’s right to use an underlying asset for the lease
term.
- UNDERLYING ASSET
 No substantive rights to substitute
 No benefits from substitution

- RIGHT TO CONTROL USE depends on: DIRECTION and ECONOMIC BENEFIT

 DIRECTION – over how and what purpose the asset is used
 ECONOMIC BENEFIT – from the use of the asset will flow to the lessee

At Commencement Date:

Right of Use Asset (@ cost) xx

Lease Liability xx

Initial measurement of the leased liability

+ Lease Prepayments
+ Initial direct cost incurred by the lessee
+ PV of estimated Restoration, Removal and Dismantling Cost
- Lease incentives received
RIGHT OF USE ASSET

PV of Future Lease payment*

+ PV of any reasonable certain purchase option
+ PV of the residual value guarantee
- Incentive receivable
LEASE LIABILITY

*If the lease payments are in advance: use Present Value of an Annuity Due
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*If the lease payments are at the end of the period: use Present Value of an Ordinary Annuity
*for Purchase Option and Residual Value Guarantee: use Present Value of 1

DEPOSITS PAID – prepayments reduce Lease Liability

- Happens when initial payments are different from annual rentals

Lease Liability xx
Cash xx

Subsequent Measurement:

Depreciation Expense xx
Right of Use Asset xx

- Depreciate the right of use asset from the commencement date to the earlier of the Useful Life of the asset and
lease term if the asset will not be transferred to the lessee.
- If the ownership of the underlying asset will be transferred to the lessee or there is a purchase option which the
lessee is expected to exercise, then depreciate over the useful life of the asset.
- If asset is an investment property that uses the revaluation model, use the revaluation model.

Total Payments
(Present Value of total payments)
DISCOUNT*

*Amortized using the effective interest method and recognized as interest expense
Interest Expense xx
Lease Liability xx
Cash xx

Lease Liability – lease payment + interest expense = Carrying Amount of Lease Liability

Interest Payment
(Interest Expense)
REDUCTION IN LEASE LIABILITY*

*If within 12 months, classify as a current liability, otherwise a non-current liability

PRESENTATION IN THE FINANCIAL STATEMENT

RIGHT OF USE ASSET – Noncurrent Asset

LEASE LIABILITY – separate Current and Noncurrent Liability

SALES AND LEASEBACK TRANSACTIONS

- Sale of an asset and the subsequent leasing of it by the original owner

- If satisfies IFRS 16 as sales, accounted as sales and leaseback
- If not, accounted as a financing

If satisfies IFRS 16 as sales, accounted as sales and leaseback

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Cash (from Sales @FV) xx

Right of Use Asset xx
Asset sold @ CA xx
Lease Liability @ PV xx
Gain on Rights Transferred xx

- RIGHT OF USE ASSET: Carrying Amount of the Asset x (PV of Lease Payment/ FV of Asset)
- Gain/Loss on Transfer: CA of Asset – FV of Asset = Gain or Loss on Sale of Asset
- Rights Retained: Gain/Loss on Sales x (PV of Lease Payment/FV of Asset)
- Gain/Loss on the Rights Transferred: Gain/Loss on Sale – Rights Retained

If not, accounted as a finance lease

SELLER/LESSEE: records Financial Liability

BUYER/LESSOR: records financial Asset

THEORIES:

1. The right of use asset is reported as

A. Noncurrent as separate line item C. Intangible asset
B. Property, Plant and Equipment D. Investment property

2. What is the interest rate used when the implicit interest rate cannot be determined?
A. The prime rate C. The lessee’s average borrowing rate
B. The lessor’s published rate D. The lessee’s incremental borrowing rate

3. Which statement concerning residual value guarantee is appropriate for the lessee?
A. The asset and related liability should be increased by the absolute amount of the residual value
B. The asset and related liability should be decreased by the absolute amount of the residual value
C. The asset and related liability should be decreased by the present value of the residual value
D. The asset and related liability should be increased by the present value of the residual value

4. If the residual value of an underlying asset is greater than the amount guaranteed by the lessee
A. The lessor pays the lessee for the difference
B. The lessee recognizes a gain at the end of the lease term
C. The lessee has no obligation related to the residual value
D. The lessee pays the lessor to the difference

5. A lessee with a lease containing a purchase option that is reasonably certain to be exercised should depreciate the
right of use asset over
A. Useful life of the asset C. UL of the asset or LT, whichever is shorter
B. Lease Term D. of the asset or LT, whichever is longer

6. In computing depreciation of right of use asset, the lessee should subtract

A. A guaranteed residual value and depreciate over the term of the lease
B. An unguaranteed residual value and depreciate over the term of the lease
C. A guaranteed residual value and depreciate over the life of the asset
D. An unguaranteed residual value and depreciate over the life of the asset

7. Which is correct statement of lease capitalization on the part of the lessor?

A. The lease transfers ownership of the property to the lessor
B. The lease contains a purchase option
C. The lease term is equal to or more than 75% of the economic life of the leased property
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D. The minimum lease payments excluding executory costs equal or exceed 90% of the fair value of the leased
property

8. The interest rate implicit in the lease is the discount rate that causes the aggregate of the present value of the minimum
lease payments and the unguaranteed residual value to equal the
A. Fair value of the leased asset
B. Fair value of the leased asset and initial direct costs of the lessor
C. Fair value of the leased asset and initial direct costs of the lessee
D. Gross investments in the lease

9. Lease payments under an operating lease shall be recognized as rent income using the
A. Cash method
B. Sum of years’ digits method
C. Declining balance method
D. Straight line method, unless another systematic basis is representative of the time pattern of the users’ benefit

10. Initial direct costs incurred by the lessor under a sales type lease should be
A. Deferred and allocated over the economic life of the leased property.
B. Expensed in the period incurred.
C. Deferred and allocated over the term of the lease in proportion to the recognition of rental income.
D. Added to the gross investment in the lease and amortized over the term of the lease as a yield adjustment.

PROBLEMS:

I. Ainee Company leased an equipment from Batina Company on January 1, 2019 under a lease with the following
pertinent information:

Annual rental payable at the end of each year 500,000

Lease term 7 years
Useful life of equipment 10 years
Implicit interest rate 11%
PV of an ordinary annuity of 1 for 7 periods at 11% 4.71
Present value of 1 for 7 periods at 11% 0.48
Lease prepayment 100,000
Lease incentive received 30,000
Present value of expected removal cost incurred 80,000

Ainee has the option to purchase the machine on January 1, 2026 by paying P400,000 which is significantly less
than the P600,000 expected fair value of the machine on the option exercise date and is expected to be reasonable
exercised. On January 1, 2019, Ainee incurred initial direct costs
of P50,000. Ainee uses the straight-line method of depreciation for all its assets with no expected residual value.

1. What is the cost of the machinery at the inception of the lease?

a. 2,547,000 c. 2,747,000
b. 2,355,000 d. 2,643,000

2. What is the balance of the lease liability on December 31, 2019?

a. 2,547,000 c. 2,047,000
b. 2,327,170 d. 2,549,170

3. What is the current portion of this lease liability on December 31, 2019?
a. 500,000 c. 244,011
b. 219,830 d. 255,989
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4. What is the depreciation expense for 2019 assuming no residual value?

a. 254,700 c. 363,857
b. 274,700 d. 392,428

II. Sitti Company leased equipment for its entire nine-year useful life, agreeing to pay P1,000,000 at the start of
the lease term on January 1, 2019, and P1,000,000 annually on each January 1, for the next eight years. The
present value on January 1, 2019, of the nine lease payments over the lease term, using the rate implicit in the
lease which Sitti knows to be 10% was P6,330,000. The January 1, 2019, present value of the lease payments
using Sitti’s incremental borrowing rate of 12% was P5,970,000. Sitti made a timely second lease payment.

1. What is the balance of the finance lease liability on December 31, 2019?
a. 6,330,000 c. 5,330,000
b. 5,970,000 d. 4,970,000

2. What is the 2020 interest expense?

a. 496,300 c. 596,300
b. 486,300 d. 547,968

3. What amount should Sitti report as finance lease liability in its December 31, 2020 statement of financial
position?
a. 4,863,000 c. 5,963,000
b. 4,963,000 d. 3,863,000

III. On January 1, 2019, Putli Company leased two automobiles for executive use. The lease requires Putli to
make five annual payments of P2,000,000 beginning January 1, 2019. At the end of the lease term at
December 31, 2023, Putli guarantees the residual value of the automobiles at P500,000. The interest rate
implicit in the lease is 12% and present value factors are as follows:

For an annuity due with 5 payments 4.04

For an ordinary annuity with 5 payments 3.60
Present value of 1 for 5 periods 0.57

1. What is the finance lease liability immediately after the first required payment?
a. 6,080,000 c. 6,365,000
b. 5,485,000 d. 5,128,800

2. What is the 2020 interest expense?

a. 763,800 c. 969,600
b. 615,456 d. 729,600

IV. On January 1, 2019, Andrea entered into a 6-year lease with a lessor. Annual lease payments of P900,000
including annual executory cost of P100,000 are payable at the end of each year. Andrea knows that the lessor
expects a 10% rate of return on the lease. Andrea has a 12% incremental borrowing rate. The equipment is
expected to have an estimated useful life of 6 years. In addition, a third party has guaranteed to pay the lessor
the residual value of P200,000 at the end of the lease. (round off present value factors to 2 decimal places)

1. What is Andrea’s total lease liability in the January 1, 2019 statement of financial position?
a. 3,488,000 c. 4,018,000
b. 3,924,000 d. 3,582,000

2. What is the lease liability balance on December 31, 2019?

a. 3,140,200 c. 3,036,800
b. 3,416,400 d. 3,140,200
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V. On January 1, 2019, Sheikha Company entered into a 10-year lease for drilling equipment. Sheikha accounted
for the acquisition as a finance lease for P4,900,000 which included a P200,000 guaranteed residual value
(gross amount). At the end of the lease, the asset will revert back to the lessor. It is estimated that the asset’s
fair value at the end of its 12 year useful life will be P100,000. Sheikha regularly uses the straight-line
depreciation on similar equipment.

1. What amount should Sheikha recognize as depreciation expense on the leased asset?
a. 490,000 c. 400,000
b. 470,000 d. 408,333

2. If the total amount capitalized as an asset was still P4,900,000 but the residual value of P200,000 is
unguaranteed, what is the depreciation to be recorded in 2019?
a. 490,000 c. 400,000
b. 470,000 d. 408,333

VI. On January 1, 2019, Fatima Company signed an eight-year noncancelable lease for a new machine requiring
P900,000 annual payments at the beginning of each year. The machine has a useful life of 10 years, with no
residual value. Title passes to Fatima at the lease expiration date. Fatima uses straight-line depreciation for all
of its plant assets. Aggregate lease payments have a present value on January 1, 2019 of P5,600,000 based on
an appropriate rate of interest. What is the 2019 depreciation expense?
a. 700,000 c. 470,000
b. 560,000 d. 612,500

VII. Kaye Company leased machinery with a fair value of P4,150,000 from another entity on December 31, 2019.
The contract is a five-year noncancelable lease with an implicit interest rate of 10 percent. The lease requires
annual payments of P1,000,000 beginning December 31, 2019. Kaye appropriately accounted for the lease as
a finance lease. Kaye’s incremental borrowing rate is 12 percent. The present value of an annuity due of 1 for
5 years at 10 percent is 4.170 and the present value of an annuity due of 1 for 5 years at 12 percent is 4.037.
What is the lease liability after the first payment that Kaye should report on the statement of financial position
at December 31, 2019?
a. 3,150,000 c. 4,170,000
b. 3,170,000 d. 3,037,000

VIII. Alesha Company is a dealer in machinery. On January 1, 2019, machinery was leased to another enterprise
with the following provisions:

Annual rental payable at the end of each year 2,000,000

Lease term 5 years
Useful life of machinery 6 years
Cost of machinery 5,000,000
Residual value - guaranteed 1,000,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
PV of 1 for 5 periods at 10% 0.62

At the end of the lease term on December 31, 2019, the machinery will be returned to Alesha. The perpetual
inventory system is used. Alesha incurred initial direct costs of P200,000 in finalizing the lease agreement.

1. What is the total financial revenue from the lease from the lease transaction?
a. 2,800,000 c. 1,800,000
b. 3,000,000 d. 3,200,000

2. What amount of profit on the sale should Alesha Company report?

a. 3,200,000 c. 3,000,000
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b. 2,000,000 d. 2,500,000

3. What amount of interest income should Alesha Company report in 2019?

a. 758,000 c. 820,000
b. 555,000 d. 920,000

4. What is the total income to be reported by Alesha from this lease in 2019?
a. 3,000,000 c. 2,800,000
b. 3,820,000 d. 820,000

IX. Jovy Financing Company leases equipment to customers under a direct financing lease arrangement for a
noncancelable period of at least 10 years. On January 1, 2019, Jovy purchased an equipment for P8,300,000
and immediately leased it to another company for 10 years. Lease payments of P1,200,000 are to be collected
at the beginning of each year and Jovy expects to earn 9% interest on leases. Jovy incurs P100,000 of initial
direct cost relating to the lease. The lease transfers the ownership of the asset to the lessee.

1. What is the total financial revenue to be earned by Jovy in this lease?

a. 3,000,000 c. 2,600,000
c. 3,600,000 d. 2,400,000

2. What is the financial revenue in 2019?

a. 648,000 c. 756,000
b. 1,080,000 d. 500,000

3. What is the carrying amount of the lease receivable to be presented in Jovy’s statement of financial
position on January 1, 2019 and December 31, 2019?
a. 12,000,000 and 10,800,000 c. 10,800,000 and 10,800,000
b. 8,400,000 and 9,156,000 d. 7,200,000 and 7,848,000

X. Krizhia Company is in the business of leasing new sophisticated equipment. As a lessor, Krizhia expects a
12% return on its net investment with payments made in advance. All leases are classified as direct financing
leases. At the end of the lease term, the equipment’s ownership is not transferred to the lessee. On January 1,
2019, equipment is leased to a lessee with the following information:

Cost of equipment to Koresh 5,250,000

Residual value – unguaranteed 600,000
Useful life and lease term 8 years
Implicit interest rate 12%
Present value of an annuity due at 12% for 8 periods 5.564
Present value of 1 at 12% for 8 periods .404

1. What is the annual rent payable in advance?

a. 900,000 c. 850,000
b. 1,000,000 d. 1,200,000

2. What is the total financial revenue from the direct financing lease transaction?
a. 2,550,000 c. 1,550,000
b. 1,950,000 d. 1,200,000

XI. 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, 2016, an equipment is leased to a lessee with the following information:

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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, 2016

1. What is the gross investment in the lease?

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

2. What is the net investment in the lease?

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

3. What is the total financial revenue?

a. 2,196,000 c. 2,556,000
b. 2,796,000 d. 1,956,000

4. What amount should be recognized as interest income for 2016?

a. 600,480 c. 536,760
b. 492,480 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
b. 3,740,000 d. 3,460,000