CHAPTER 14

SALES TYPE LEASE - LESSOR

TECHNICAL KNOWLEDGE
To understand a sales type lease on the part of lessor.
To define gross investment and net investment in a sales type lease.
To recognize profit on sale and interest income in a sales type lease.

Introduction
The lessor in a sales type lease is actually a manufacturer or dealer that uses the lease as a means
of facilitating the sale of product
The accounting for a sales type lease exhibits many similarities to that for a direct financing
lease.
However, a sales type lease involves the recognition of a manufacturer or dealer profit on the
transfer of the asset to the lessee in addition to the recognition of interest income.

Accounting considerations
Gross investment - This is equal to the gross rentals for the entire lease term plus the absolute
amount of the residual value, whether guaranteed or unguaranteed.
Recall that this is the same gross investment in a direct financing lease.
Net investment in the lease – This is equal to the present value of the gross rentals plus the
present value of the residual value, whether guaranteed or unguaranteed.
Unearned interest income - This is the difference between the gross investment and net
investment in the lease.
Sales – The amount is equal to the net investment in the lease (present value of lease payments)
or fair value of the asset, whichever is lower.
Cost of goods sold – This is equal to the cost of the asset sold minus the present value of
unguaranteed residual value plus the initial direct cost paid by the lessor.
Gross profit - This is the usual formula of sales minus cost of goods sold.
Initial direct cost - This amount is expensed immediately in a sales type lease as component of
cost of goods sold.

Illustration
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%
Present value of annuity of 1 for 5 years at 12% 3.60

Computation
Gross rentals (400,000 x 5) 2,000,000
Present value of rentals (400,000 x 3.60) 1,440,000
Unearned interest income 560,000
Present value of rentals – sales 1,440,000
Cost of machinery - cost of goods sold 1,000,000
Gross profit on sale 440,000
A manufacturer or dealer lessor shall recognize selling profit or loss in income for the period in
accordance with the policy followed by the entity for outright sale.
Journal entries
On the books of Lessor Company, the sales type lease is recorded as follows:
1. To record the sale:
Lease receivable 2,000,000
Sales 1,440,000
Unearned interest income 560,000
The gross profit of P440,000 is not separately recorded because it is included already in the sales
revenue.

2. To record the cost of goods sold, assuming the perpetual system is used:
Cost of goods sold 1,000,000
Inventory 1,000,000

3. To record the collection of the annual rental:

Cash 400,000
Lease receivable 400,000

4. To record the interest income for 2020:

Unearned interest income 172,800
Interest income 172,800

Present value - January 1, 2020 1,440,000

December 31, 2020:
Payment 400,000
Interest for 2020 (12% x 1,440,000) (172,800) 227,200
Balance - December 31, 2020 1,212,800

Sales type lease with residual value

Lessor Company is a dealer in machinery.
On January 1, 2020, a machinery is leased to another entity 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%
Present value of an ordinary annuity of
1 for 5 periods at 10% 3.7908
Present value 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.

Residual value guarantee

Gross rentals (800,000 x 5) 4,000,000
Residual value guarantee 200,000
Lease receivable - gross investment 4,200,000

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

Present value of residual value guarantee
(200,000 x.6209) 124,180
Total present value - net investment 3,156,820

Lease receivable 4,200,000

Total present value (3,156,800)
Unearned interest income 1,043,180

Sales equal to total present value 3,156,800

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

Journal entries on January 1, 2020

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

The initial direct cost is charged directly to cost of goods sold.

Unguaranteed residual value
Gross rentals (800,000 & 5) 4,000,000
Unguaranteed residual value 200,000
Lease receivable - gross investment 4,200,000

Present value of gross rentals 3,032,640

Present value of unguaranteed residual value 124,180
Total present value - net investment 3,156,820

Lease receivable 4,200,000

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

Observe that the lease receivable and unearned interest income are the same whether the scenario
is guaranteed or unguaranteed residual value.
However, there is a difference in the computation of the sales and cost of goods sold.
Under the residual value guarantee scenario, the present value of the residual value is included in
the sales revenue because the lessor knows that the entire asset has been sold.
However, under the unguaranteed residual value scenario, the present value of the unguaranteed
residual value is not included in the sales revenue.
Accordingly, the present value of the unguaranteed residual value is deducted from the cost of
the underlying asset in computing cost of goods sold.
The reason is that this portion of the leased asset is in effect "not sold" in the sense that the lessor
will be receiving back at the end of the lease term the underlying asset with unguaranteed
residual value of P200,000 and present value of P124, 180
Moreover, the unguaranteed residual value is not considered lease payment as far as the lessee is
concerned.

Computation
Cost of machinery 2,000,000
PV of unguaranteed residual value (124,180)
Cost of goods sold 1,875,820

Sales equal to present value of

only, excluding the present value of the
unguaranteed residual value 3,032,640
Cost of goods sold (1,875,820)
Initial direct cost (100,000)
Gross income 1,056,820
Note that the gross income must be the same under the guaranteed and unguaranteed residual
value scenario.
Journal entries
The journal entries to record the sale and the initial direct cost on January 1, 2020 under the
concept of unguaranteed residual value are:
Lease receivable 4,200,000
Cost of goods sold 1,875,820
Sales 3,032,640
Unearned interest income 1,043,180
Inventory 2,000,000
Cost of goods sold 100,000
Cash 100,000

Table of amortization
The table of amortization of the net lease receivable may follows:
Date Payment Interest Principal Present value
1/1/2020 3,156,820
12/31/2020 800,000 315,682 484,318 2,672,502
12/31/2021 800,000 267,250 532,750 2,139,752
12/31/2022 800,000 213,975 586,025 1,553,727
12/31/2023 800,000 155,373 644,627 909,100
12/31/2024 800,000 90,900 709,100 200,000

December 31, 2020

Payment 800,000
Applicable to interest (10% x 3,156,820) (315,682)
Applicable to principal 484,318
Net lease receivable - January 1, 2020 3,156,820
Payment on December 31, 2020 (484,318)
Carrying amount - December 31, 2020 2,672,502

Whether guaranteed or unguaranteed, the entries for the collection of the annual rental and the
interest income are the same.
Journal entries - December 31, 2020
1. Cash 800,000
Lease receivable 800,000

2. Unearned interest income 315,682

Interest income 315,682
Return of asset to lessor
When the lease expires on December 31, 2024, the machinery will revert to Lessor Company.
Whether guaranteed or unguaranteed residual value, the entry on the books of the lessor will be
the same.
Inventory (machinery) 200,000
Lease receivable 200,000
To complete the illustration, assume on December 31, 2024 end of lease term, the fair value of
the machinery is only P150,000.
Under the residual value guarantee scenario, the lessee will make up for the deficiency by paying
the difference.
Cash 50,000
Inventory 150,000
Lease receivable 200,000

Under the unguaranteed scenario, the lessor shall recognize a loss for the difference.
Logs on finance lease 50,000
Inventory 150,000
Lease receivable 200,000

It is to be pointed out that in the illustration the sales type lease provides that the underlying asset
will revert to the lessor upon termination of the contract.
However, if the underlying asset will not revert to the lessor, the residual value is completely
ignored by the lessor in the computation of unearned interest income and gross profit on the sale.
The underlying asset will remain with the lessee if the lease provides for either a purchase option
that is reasonably certain to be exercised or transfer of title to the lessee upon the lease
expiration.

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.
Computation
Gross rentals (500,000 x 4) 2,000,000
Purchase option 200,000
Gross investment - lease receivable 2,200,000

Present value of gross rentals (500,000 x 3.312) 1,656,000

Present value of purchase option (200,000 x 735) 147,000
Total present value - net investment 1,803,000

Gross investment 2,200,000

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

Sales (equal to total present value) 1,803,000

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

Journal entry - January 1, 2020

If the perpetual system is used, the journal entry to record the sale is:
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

Table of amortization
The table of amortization of the net lease receivable may appear as follows:
Date Payment Interest Principal Present
value
Jan. 1, 2020 1,803,000
Dec. 31, 2020 500,000 144, 240 355,760 1,447,240
Dec. 31, 2021 500,000 115,779 384,221 1,063,019
Dec. 31, 2022 500,000 85,042 414,958 648,061
Dec. 31, 2023 500,000 51,939 448,061 200,000
Payment represents the annual rental.
Interest is equal to the preceding present value times the interest rate.
Thus, for 2020, P1,803,000 times 8% equals P144,240, and so on.
Principal is the portion of the annual rental payment after deducting interest.
Thus, for 2020, P500,000 minus P144,240 equals P355, 760 and so on.
Present value is the balance of the present value after deducting the principal payment.
Thus, on December 31, 2020, P1,803,000 minus P355,760 equals P1,447,240 and so on.
Journal entries.
2020
Dec. 31 Cash 500,000
Lease receivable 500,000
31 Unearned interest income 144,240
Interest income 144,240
2021
Dec. 31 Cash 500,000
Lease receivable 500,000
31 Unearned interest income 115,779
Interest income 115,779
2022
Dec. 31 Cash 500,000
Lease receivable 500,000
31 Unearned interest income 85,042
Interest income 85,042
2023
Dec. 31 Cash 500,000
Lease receivable 500,000
31 Unearned interest income 51,939
Interest income 51,939

Exercise of purchase option

At this point on December 31, 2023, if the entries are posted, the lease receivable has balance of
P200,000 equal to the purchase option and the unearned interest income has a zero balance.
The purchase option is exercised by the lessee on December 31, 2023.
Journal entry
 Cash 200,000
Lease receivable 200,000
Nonexercise of purchase option
The purchase option is not exercised by the lessee and the fair value of the underlying asset is
P100,000 only.
Journal entry
Inventory 100,000
Loss on finance lease 100,000
Lease receivable 200,000

Actual sale of underlying asset

When a lessor actually sells an asset that it has been leasing under a finance lease, the difference
between the sale price and the carrying amount of the lease receivable is recognized in profit or
loss.
The carrying amount of the lease receivable is equal to the balance of the lease receivable minus
the unearned interest income.
Illustration
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
Computation
Sale 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

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

Disclosures - Lessor
A lessor shall disclose the following amounts for the reporting period:
1. For finance lease:
a. Selling profit or loss
b. Finance income on the net investment in the lease
c. Income relating to variable lease payments not included in the measurement of the net
investment in the lease
2. For operating lease, lease income, separately disclosing income relating to variable lease
payments that do not depend on an index or rate
Additional disclosures
A lessor shall disclose additional qualitative and quantitative information about leasing activities
necessary to assess the effect of leases on financial position, financial performance and cash
flows.
This additional information includes, but is not limited to, information that helps users of
financial statements to assess:
1. The nature of the lessor's leasing activities
2. How the lessor manages the risks associated with any rights it retains in the underlying asset.

In particular, a lessor shall disclose its risk management strategy for the rights it retains in
underlying asset including any means by which the lessor reduces that risk.

QUESTIONS
1. Explain a sales type lease.
2. Explain the following in a sales type lease:
a. Gross investment
b. Net investment
c. Unearned interest income
d. Sales
e. Cost of goods sold
f. Gross profit
3. What is the treatment of initial direct cost paid by the lessor in a sales type lease?
4. Explain the treatment of residual value in a sales type lease.
5. Explain the treatment of purchase option in a sales type lease.
6. Explain the "actual sale" of the underlying asset by the lessor to the lessee.

PROBLEMS
Problem 14-1 (AICPA Adapted)
On January 1, 2020, Anne Company leased equipment to Meg Company for an eight-year period
expiring January 1, 2028
Equal payments under the lease are P600,000 and are due on January 1 of each year. The first
payment was made of January 1, 2020. The rate of interest contemplated is 10%
The cash selling price of the equipment is P3,520,000, and the cost of the equipment is
P2,800,000.
Anne Company paid initial direct costs of P50,000 in negotiating and arranging the lease. The
lease is appropriately recorded as a sales type lease.
Required:
Prepare journal entries on the books of Anne Company for 2020 and 2021.

Problem 14-2 (AICPA Adapted)

On January 1, 2020, Fox Company, dealer in equipment, leased equipment to Tiger Company.
The lease is appropriately accounted for as a sale by Fox Company and as a purchase by Tiger
Company.
The lease is for a 10-year period which approximates the useful life of the asset. The first of 10
equal annual payments of P500,000 was made on January 1, 2020.
Fox Company purchased the equipment for P2,675,000 and established a list selling price of
P3,375,000 on the equipment. Fox Company used the perpetual inventory system.
The present value on January 1, 2020 of the rent payments over the lease term discounted at 12%
was P3,165,000.
Required:
Prepare journal entries for 2020 and 2021 on the books of Fox Company and Tiger Company.

Problem 14-3 (IAA)

Universal Company used leases as a method of selling products. At the beginning of current
year, Universal Company leased equipment to National Company with the following
information:
Annual rental payable at the end of each lease year 700,000
Cost of equipment to Universal 2,000,000
Unguaranteed residual value 400,000
Useful life of equipment and lease term 8 years
Implicit interest rate in the lease 12%
PV of an ordinary annuity of 1 for 8 periods at 12% 4.968
PV of 1 for 8 periods at 12% 0.404
At the end of the lease the equipment will revert to the lessor. Both lessor and lessee report on a
calendar year basis, depreciate all assets on the straight line, and use the perpetual inventory
system.
Required:
Prepare journal entries on the books of Universal Company and National Company for the
current year.

Problem 14-4 (IAA)

Vanderbilt Company is a dealer in machinery. The perpetual inventory system is used. At the
beginning of current year, a machinery was leased to Thunder Company with the following
provisions:
Annual rental payable at the end of each year 3,000,000
Lease term and useful life of machinery 5 years
Cost of machinery 5,000,000
Residual value guarantee 1,000,000
Initial direct cost paid by Vanderbilt 300,000
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
Required:
Prepare journal entries on the books of Vanderbilt Company and Thunder Company for the
current year.
Problem 14-5 (IAA)
Angola Company used leases as the primary method of selling is very popular among
government officials and corporate products. The entity's main product is a small aircraft that
executives.
Angola Company constructed such aircraft for a President of a big corporation at a cost of
P8,000,000.
The terms of the lease provided for annual rental of P3,328,710 to be paid over 5 years every
December 31 of each year with the ownership of the aircraft transferring to the lessee at the end
of the lease term.
It is estimated that the aircraft will have a residual value of P500,000 after 5 years.
Angola Company incurred initial direct costs of P200,000 in finalizing the lease with the lessee.
Financing the construction was at a 12% rate. The present value of an ordinary annuity of 1 for 5
periods at 12% is 3.605.
Required:
1. Compute the total unearned financial revenue.
2. Compute the manufacturer profit to be recognized immediately.
3. Compute the interest income for the first year.
4. Prepare journal entries for the first year relating to the sales type lease on the books of the
lessor.

Problem 14-6 (IAA)

On April 1, 2020, Oriental Company leased equipment to another entity. The lease is
appropriately recorded as a sales type lease and is for an 8-year period with an implicit interest
rate of 10%. The first of eight equal payments of P700,000 was made on April 1, 2020.
The cost of the equipment to Oriental Company is P3,700,000. The equipment has an estimated
useful life of 8 years with no residual value
The present value of an annuity of 1 in advance at 10% for 8 periods is 5.868. The entity follows
the calendar year and uses the perpetual inventory system.
Required:
1. Determine the total financial revenue.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2020 and 2021.

Problem 14-7 (IAA)

Negros Company used leases a method of selling products and followed the perpetual inventory
system.
In early 2020, Negros Company completed construction of a passenger ferry for use between
Bacolod and Iloilo.
On April 1, 2020, the ferry was leased to another entity on a contract specifying that ownership
of the ferry will transfer to the lessee at the end of the lease term.
Cost of ferry to Negros Company 6,000,000
Annual rental payable in advance 900,000
Estimated residual value 300,000
Implicit interest rate 12%
Lease period 20 years
Date of first rental payment April 1, 2020
PV of an annuity of 1 in advance at 10% for 20 periods 9.36
PV of 1 at 10% for 20 periods 0.15
Required:
1. Determine the total financial revenue.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2020 and 2021.

Problem 14-8 (IAA)

Salome Company is a dealer in equipment. On 2020, the entity leased an equipment to another
entity. The lease is appropriately recorded as a sales type lease.
Annual rental payable at the beginning of each year 800,000
Lease term 8 years
Useful life of equipment 10 years
Cost of equipment 3,100,000
Purchase option 400,000
Implicit interest rate 10%
PV of an annuity of 1 in advance at 10% for 8 periods 5.87
PV of 1 at 10% for 8 periods 0.47

It is reasonably certain that the lessee will exercise the purchase option on the expiration of lease
on December 31, 2027.
The perpetual inventory system is used by Salome Company
Required:
1. Determine the unearned interest income on January 1, 2020.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2020 and 2021.
4. Prepare journal entry on December 31, 2027 to record the exercise of the bargain purchase
option by the lessee.
5. Prepare journal entry on December 31, 2027 if the bargain purchase option is not exercised by
the lessee and the fair value of the leased asset is P250,000.
Problem 14-9 (IAA)
On January 1, 2020, Esmeralda Company leased equipment to another entity.
The terms of the lease called for annual payment of P500,000 to be made at the end of each year.
The lease term is 5 years which is the useful life of the equipment.
The lease is appropriately recorded as a sales type lease,
The cost of the equipment is P1,000,000.
The implicit interest rate in the lease is 12%. The PV of an ordinary annuity of 1 at 12% for 5
periods is 3.60.
On July 1, 2022 Esmeralda Company "actually sold" the equipment to the lessee for P1,200,000.
Required:
1. Determine the unearned interest income on January 1, 2020.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2020, 2021 and 2022 to record the sales type lease and the actual
sale of the underlying asset. The periodic system is used.
Problem 14-10 (AICPA Adapted)
At the beginning of current year, Howe Company leased equipment to Kew Company for an
eight-year period.
Equal payments under the lease are P500,000 and are due at the beginning of each year.
The selling price of the equipment is P2,900,000 and the carrying amount is P2,000,000. The
lease is appropriately accounted for as a sales type lease.
The present value of the lease payments at an implicit interest rate of 12% is P2,780,000.
What amount of profit on the sale should be reported for the current year?
a. 900,000
b. 780,000
c. 240,000
d. 333,600

Problem 14-11 (IFRS)

Gold Company leased equipment to Fair Company and properly recorded the sales type lease.
The eight annual payments of P300,000 are due at the beginning of each year.
The lessor had purchased the equipment for P1,100,000 and had a list price of P1,800,000.
The present value of the lease payments is P1,700,000. The imputed interest rate on the lease
was 11% and the lessee had an incremental borrowing rate of 10%.
1. What profit on sale should be reported in the current year?
a. 380,000
b. 600,000
c. 220,000
d. 0
2. What amount of interest income should be reported in the current year?
a. 165,000
b. 140,000
c. 187,000
d. 154,000

Problem 14-12 (AICPA Adapted)

On July 1, 2020, Meg Company leased equipment to Wee Company for an 8-year period.
Equal payments under the lease are P600,000 and are due on July 1 of each year. The first
payment was made on July 1, 2020
The interest rate contemplated by Meg Company and Wee Company is 10%.
The cash selling price of the equipment is P3,520,000 and the cost of the equipment on Meg
Company's accounting records is P2,800,000.
The lease is appropriately recorded as a sales type lease.
1. What amount of profit on sale should be recognized for the year ended December 31, 2020?
a. 600,000
b. 720,000
c. 360,000
d. 300,000
2. What amount of interest revenue should be recorded for the year ended December 31, 2020?
 a. 292,000
b. 146,000
c. 352,000
d. 176,000

Problem 14-13 (AICPA Adapted)

On January 1, 2020, Gallant Company entered into a lease agreement with Blacksheep Company
for a machine which was carried on the accounting records of Gallant Company at P2,000,000.
Total payments under the lease which expires on December 31, 2029 aggregate P3,550,800 of
which P2,400,000 represents cost of the machine to Blacksheep Company. Payments of 31, 2029
aggregate P3,550,800 of which P2,400,000 represents P355,080 are due each January 1 of each
year.
The interest rate of 10% which was stipulated in the lease is considered fair and adequate
compensation to Gallant Company
Blacksheep Company expects the machine to have a 10-year life, no residual value and be
depreciated on a straight line basis. The lease qualifies as a sales type lease.
1. What amount should be recognized by Gallant as profit from sale for the year ended
December 31, 2020?
a. 1,150,800
b. 1,550,800
c. 400,000
d. 355,080
2. What amount of interest income should be recognized by Gallant for the year ended December
31, 2020?
a. 244,080
b. 200,000
c. 204,492
d. 240,000
3. What total income before tax should be recognized by Gallant from the lease for the year
ended December 31 2020?
a. 204,492
b. 604,492
c. 355,080
d. 755,080

Problem 14-14 (IAA)

Reagan Company used leases as a method of selling products. In 2020, Reagan Company
completed construction of a passenger ferry.
On January 1, 2020, the ferry was leased to the Super Ferry transfer to the lessee at the end of the
lease period.
Line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of
the lease period
Original cost of the ferry 8,000,000
Fair value of ferry at lease date 13,000,000
Lease payments in advance 1,500,000
Residual value 2,000,000
Implicit interest rate 12%
Date of first lease payment January 1, 2020
Lease term 20 years
Present value of an annuity due of 1 at 10% for 20 periods 8.37
Present value of 1 at 12% for 20 periods 0.10
1. What is the gross investment in the lease?
a. 30,000,000
b. 32,000,000
c. 10,000,000
d. 38,000,000
2. What is the net investment in the lease?
a. 12,555,000
b. 13,000,000
c. 12,755,000
d. 8,000,000
3. What is the gross profit on sale for 2020?
a. 6,555,000
b. 4,555,000
c. 5,000,000
d. 7,000,000
4. What is the interest income for 2020?
a. 1,506,600
b. 1,560,000
c. 1,326,600
d. 1,380,000

Problem 14-15 (IAA)

France Company is a dealer in equipment. At the beginning of current year, an equipment was
leased to another entity with the following provisions:
Annual rental payable at the end of each year 1,500,000
Lease term and useful life of machinery 5 years
Cost of equipment 4,000,000
Residual value-unguaranteed 500,000
Implicit interest rate 12%
PV of an ordinary annuity of 1 at 12% for 5 periods 3.60
PV of 1 at 12% for 5 periods 0.57
At the end of the lease term the equipment will revert to the lessor.
The entity incurred initial direct cost of P200,000 in finalizing the lease agreement.
1. What is the gross investment in the lease?
a. 7,500,000 b. 3,000,000
c. 4,000,000 d. 4,500,000
2. What is the net investment in the lease?
a. 5,400,000 b. 5,685,000
c. 4,000,000 d. 3,500,000
3. What interest income should be reported for current year?
a. 682,200 b. 648,000
 c. 900,000 d. 960,000
4. What amount should be reported as gross profit on sale!
a. 1,485,00 b. 1,685,000
c. 3,500,000 d. 4,000,000

Problem 14-16 (IAA)

Rizza Company used leases as a method of selling products. In the current year, Rizza Company
completed construction of machinery
At the beginning of current year, the machinery was leased on a contract specifying that
ownership of the machinery will transfer to the lessee at the end of the lease period. The annual
lease payments do not include executory cost.
Original cost of the machinery 9,000,000
Lease payments payable at beginning of each year 2,000,000
Estimated residual value 1,000,000
Implicit interest rate 12%
Lease term 10 years
Present value of an annuity due of 1 at 12%
for 10 periods 6.33
Present value of 1 at 12% for 10 periods 0.32
1 What is the total financial revenue over the lease term?
a. 8,340,000 b. 7,340,000
c. 8,020,000 d. 6,340,000
2. What amount should be reported as gross profit on sale?
a. 3,980,000 b. 3,660,000
c. 7,340,000 d. 8,020,000
3. What is the interest income for current year?
a. 1,557,600 b. 1,317,600
c. 1,279,200 d. 1,519,200

Problem 14-17 (IAA)

Marianas Company adopted the policy of leasing as the primary method of selling products. The
entity's main product is a small cargo vessel. Marianas Company constructed such a cargo vessel
for Jade Company at a cost of P8,500,000.
The terms of the lease provided for annual advance payments of P2,500,000 to be paid over 10
years with the ownership transferring to Jade Company at the end of the lease period. It is
estimated that the cargo vessel will have a residual value of P1,600,000 at that date.
The lease payments began at the beginning of current year. Marianas Company incurred initial
direct cost of P500,000 in financing the lease agreement with Jade Company. The sale price of
the cargo vessel is P14,875,000.
Financing the construction was at a 14% rate. The present value of an annuity due of 1 at 14%
for 10 periods is 5.95.
1. What amount should be reported as gross profit on sale for the current year?
a. 5,875,000 b. 6,375,000
c. 4,275,000 d. 4,775,000
2. What is the unearned interest income at the beginning of current year?
a. 10,125,000 b. 11,725,000
 c. 9,625,000 d. 8,525,000
3. What is the interest income for the current year?
a. 2,082,500 b. 1,732,500
c. 2,306,500 d. 1,956,500

Problem 14-18 (IAA)

On January 1, 2020, Dexter Company leased equipment to another entity. The lease is for an
eight-year period expiring December 31, 2027.
The first of eight equal annual payments of P900,000 was made on January 1, 2020
Dexter Company had previously purchased the equipment for P4,800,000. The lease is
appropriately accounted for as a sales type lease by Dexter Company.
The present value on January 1, 2020 of all rent payments over the lease term discounted at a
10% interest rate was P5,280,000
What amount of interest revenue should be recorded in 2021?
a. 490,000
b. 480,000
c. 438,000
d. 391,800

Problem 14-19 (IFRS)

Liza Company is a car dealer. On January 1, 2020, the entity entered into a finance lease with a
customer under which the customer would pay P200,000 on January 1 each year for 5 years,
commencing in 2020.
The cost of the car is P600,000 and the cash selling price was P750,000. The entity paid legal
fees of P20,000 to a law firm in connection with the arrangement of the lease.
What amount of gross profit on sale should be recognized for the year ended December 31,
2020?
a. 150,000
b. 130,000
c. 20,000
d. 0

Problem 14-20 Multiple choice (IFRS)

1. Under a sales type lease, what is the meaning of investment in the lease?
a. Present value of lease payments
b. Absolute amount of lease payments
c. Present value of lease payments plus present value of unguaranteed residual value
d. Sum of absolute amount of lease payments and unguaranteed residual value

2. Net investment in a sales type lease is equal to

a. Gross investment in the lease less unearned finance income
b. Cost of the underlying asset
c. The lease payments
d. The lease payments less unguaranteed residual value
3. Which statement characterizes a sales type lease?
a. The lessor recognizes only interest revenue over the useful life of the asset.
 b. The lessor recognizes only interest revenue over the lease term.
c. The lessor recognizes a dealer profit at lease inception and interest revenue over the
lease term.
d. The lessor recognizes a dealer profit at lease inception and interest revenue over the
useful life of the asset.
4. The profit on a finance lease transaction for lessors who are manufacturers or dealers should
a. Not be recognized separately from finance income
b. Be recognized in the normal way on the transaction
c. Only be recognized at the end of the lease term
d. Be recognized on a straight line basis over the lease term
5. The sales revenue recognized at the commencement of the lease by a manufacturer or dealer
lessor is the
a. Fair value of the asset
b. Present value of the lease payments
c. Fair value of the asset or present value of the lease payments, whichever is lower.
d. Fair value of the asset or present value of the lease payments, whichever is higher.
6. What is the treatment of an unguaranteed residual value in determining the cost of goods sold
under a sales type lease?
a. The unguaranteed residual value is ignored.
b. The unguaranteed residual value is added to the cost of the underlying asset.
c. The unguaranteed residual value is deducted from the cost of the underlying asset at
absolute amount.
d. The unguaranteed residual value is deducted from the cost of the underlying asset at
present value.
7. The excess of the fair value of underlying asset at the inception of the lease over the carrying
amount shall be recognized by the dealer lessor as
a. Unearned income from a sales type lease
b. Unearned income from a direct financing lease
c. Manufacturer profit from a sales type lease
d. Manufacturer profit from a direct financing lease
8. In a lease that is recorded as a sales type lease by the lessor, interest revenue
a. Does not arise
b. Shall be recognized over the lease term using the interest method
c. Shall be recognized over the lease term using the straight line method
d. Shall be recognized in full as revenue at the inception of the lease