Auditing Problems

IAS 17: LEASES (0ld standard) Dr. Glen de Leon, CPA

A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments, the
right to use an asset for an agreed period of time.

Types of Lease

1. Finance Lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an
asset. Title may or may not eventually be transferred.
2. Operating Lease is a lease other than a finance lease.

Dates Relevant to a Contract of Lease

(Inception date vs. Commencement date)

Inception Date Commencement Date

 The earlier between the date of agreement or  The date when lessee is entitled to exercise its right
commitment by the parties on the terms of the lease to the lease assets.
contract.

 Amounts to be recognized at the commencement  Initial recognition of assets, liabilities, income and
date are determined. expenses related to the lease.

 Classification of the lease, as to whether finance or

operating lease is determined.

Criteria for Classification of Lease as Finance Lease

Major Criteria

Under PAS 17, among others, ANY of the following situations would normally lead to a lease being classified as
finance lease:

1) Transfer of ownership (Lease to own)

The lease transfers ownership of the leased asset to the lessee at the end of the lease term.

2) Bargain purchase option.

The lease provides that the lessee has the option to purchase the leased asset at a price sufficiently lower than
the fair value of the asset at the date of option becomes exercisable, and that at the inception of the lease, it is
reasonably certain that the option will be exercised.

FMV 6M
1m 1m 1m 1m 1m
_______1____________2___________3____________4_____________5___________
BPO
BPO 1M

3) Major part of the economic life

PAS 17: LEASES 1

 The lease term is for the major part of the economic life of the asset even if the title is not transferred. Under the
US GAAP, “major part” means at least 75% of the economic life of the asset.

20 YEARS ECONOMIC LIFE

_____________________________________________________________

15/20 = 75%

The Lease term is the non-cancellable period for which the lessee has contracted to lease the asset together
with any further terms for which the lessee has the option to continue to lease the asset, with or without further
payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option.

4) Substantially all of the fair value of leased asset

The present value of the minimum lease payment amounts to substantially all the fair value of the of the leased
asset at the inception of the lease. Under the US GAAP, “substantially all” means at least 90% of the fair
value of the leased asset.

PV OF RENTAL PAYMENTS XXXX

PLUS PV OF BPO/GSV XXXX
PV OF MLP XXXX 900,000 / 1,000,000 = 90%

5) Specialized nature
The leased asset is of such specialized nature that only the lessee can use it without major modification.

Other Criteria

Other situations that individually or in combination could also lead to a lease being classified as finance lease are:

1) Specialized nature
The leased asset is of such specialized nature that only the lessee can use it without major modification.

2) Losses are borne by the lessee

If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee.

3) Gain or losses from changes in fair value accrue to the lessee

Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee, for example, in the
form of rent rebate equaling most of the sales proceeds at the end of the lease.

4) Extension of lease term at the option of the lessee

The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than
market rent.

Summary of Accounting for Operating Lease

Payments Made by Lessee

Books of the Lessee Books of the lessor

 Periodic Rental Rental Expense Rental Income

 Unequal Rental Payments *Total payments will be Total collections will be

recognized as rental expense over recognized as rental income over
the lease term the lease term.

 Lease bonus *Recognized as an asset (prepaid Recognized as liability (unearned

rent or leasehold rights) and to be rent income) and to be amortized
amortized over the lease term over the lease term.

 Contingent rent Added to rent expense in the Added to rent income in the period
period which they arise which they arise

 Refundable security deposit Recognized as an asset (non- Recognized as a liability (non-

current) and may be affected by current) and may be affected by
time value of money time value of money

*Note: Method of amortization to be used should be straight-line basis, unless another systematic basis is

PAS 17: LEASES 2

 representative of the time pattern of the user’s benefit.

Formulas for periodic rental income/expense arising from:

a) Lease bonus
Lease bonus XX
Divided by: Lease term XX
Rental income/expense XX

b) Unequal rental payments

Total payments for the entire lease term XX
Divided by: Lease term XX
Rental income/expense XX

Accrued/Prepaid Rent
Total rental expense to date XX
Less: Total payments to date XX
Accrued/(Prepaid) Rent XX

(In the point of view of the Lessor, change the expense to income, accrued rent to rent receivable and prepaid rent to
unearned rent income)

Other Costs Incurred

Books of the Lessee Books of the Lessor

 Initial direct costs (e.g. professional fees and commissions)

a. If paid by the lessee Expense Ignore

b. If paid by the lessor Ignore Capitalized as part of the cost of the

leased asset and to be recognized as
expense over the lease term on the
same basis as the lease income.

 Executory costs (e.g. property taxes, insurance and maintenance costs)

a. If paid by the lessee Expense Recognize as income equal to the

amount paid by the lessee.

At the same time, the lessor shall

recognize expense for the payment
made to other parties related to the
executory costs.

b. If paid by the lessor Ignore Expense

Other Items Related to an Operating Lease

Books of the Lessee Books of the Lessor

Leased assets Not recognized Continued to be recognized in the

books and will be depreciated using
method as required by the lessor’s
policy.

Leasehold improvements Capitalized as an asset and Ignored

depreciated over its useful life or
term of the lease, whichever is
shorter

PAS 17: LEASES 3

 .

Residual value is generally set at

ZERO since improvements will
revert to the lessor at the end of the
lease term.

Depreciation method to be used will

depend on the lessee’s policy.

OPERATING LEASE (Traditional/conventional)

Transactions Lessee Lessor

1. Periodic rental Rent expense xx Cash xx
Cash xx Rent income xx
2. Lease bonus Prepaid rent xx Cash xx
Cash xx Unearned rent xx

Rent expense xx Unearned rent xx

Prepaid rent xx Rent income xx
3. Leasehold Leasehold improvement xx
improvement Cash xx
No entry
Depreciation expense xx
Accumulated depreciation xx
4. Security deposit Deposit for rent xx Cash xx
Cash xx Liability for sec. dep. xx
5. Initial direct costs Deferred initial direct costs xx
Cash xx
No entry
Amortization of I.D.C xx
Deferred initial direct costs xx
6. Repairs and No entry Repairs and maintenance xx
maintenance Cash xx
7. Executory cost Expense xx
(property taxes, Cash xx
insurance and
maintenance costs)

Conrado Valix (CPAR) Conrado Uberita (RESA)

EQUIPMENT 100,000/10 EQUIPMENT 100,000/10
CASH 100,000 CASH 100,000

DIDC 10,000/5 EQUIPMENT 10,000/5

CASH 10,000 CASH

PAS 17: LEASES 4

 DEPRECIATION EXPENSE 10,000 DEPRECIATION EXPENSE 10,000
ACCU. DEP 10,000 ACCU. DEP 10,000

AMORT. OF DIDC 2,000 DEPRECIATION EXPENSE 2,000

DIDC 2,000 ACCU. DEP 2,000

EQUIPMENT 100,000 EQUIPMENT 110,000

DIDC 8,000 LESS ACCU. DEP 12,000
TOTAL 108,000 CV 98,000
LESS ACCU. DEP 10,000
CV 98,000

Problem 1

ABC company purchased an equipment on January 1, 2014 for P3,000,000 cash for the purpose of leasing it. The
machine is expected to have a 10 year life from the date of purchase.

On April 1, 2014, the equipment was leased to XYZ company for a three-year period, at a monthly rental of
P40,000, payable at the end of every month.

Additionally, XYZ paid P120,000 to ABC on April 1, 2014 as a lease bonus. ABC paid repairs of P20,000 relating to
2014.

Required: Prepare the entries on the books of the lessee and lessor following the operating lease
concept.

Lessor (ABC) Lessee (XYZ)

1/1/14 EQUIPMENT 3,000,000/10 NO ENTRY
CASH 3,000,000

APRIL - DECEMBER

CASH 360,000 RENT EXPENSE 360,000

RENT INCOME 360,000 CASH 360,000

4/1/14 CASH 120,000 PREPAID RENT 120,000/3

UNEARNED RENT 120,000/3 CASH 120,000

REPAIR EXPENSE 20,000

CASH 20,000

DEPRECIATION EXP 300,000

ACCU. DEP 300,000

UNEARNED RENT 30,000 RENT EXPENSE 30,000

RENT INCOME 30,000 PREPAID RENT 30,000

Problem 2

On March 20, 2014, ABC company purchased a machine for P2,400,000 for the purpose of leasing it to others. The
machine is expected to have a 10-year life and no residual value. It will be depreciated on the straight line basis
computed to the nearest month.

MARCH 1 - 15 = MARCH 1

PAS 17: LEASES 5

MARCH 16 - 31 = APRIL 1

The machine was leased to XYZ company on April 1, 2014 for four years, at a monthly rental of P36,000. There is no
provision for renewal of the lease or purchase of the machine by the lessee upon expiration of the lease.

ABC paid P120,000 initial direct costs associated with negotiating the lease in March 2014.

Required: Prepare journal entries on the books of the lessor and lessee for 2014.

Lessor Lessee
3/20/14 MACHINE 2,400,000/10
CASH 2,400,000

APRIL - DECEMBER (36,000 X 9)

CASH 324,000 RENT EXPENSE 324,000

RENT INCOME 324,000 CASH 324,000

DIDC 120,000/4
CASH 120,000

DEPRECIATION EXP 180,000

ACCU. DEP 180,000

AMORT. OF DIDC 22,500

DIDC 22,500

Problem 3

On December 1, 2014, ABC company leased office space for five years at a monthly rental of P60,000. On the same
date, ABC paid the lessor the following amounts:

First month’s rent ………………………………………………………………………..P 60,000 DECEMBER

Second month’s rent …………………………………………………………………… 60,000 JANUARY
Security deposit (refundable at lease expiration) ……………………….. 80,000
Installation of new walls and offices …………………………………………… 360,000

Required: Prepare all indicated entries on the books of lessee for the month of December

RENT EXPENSE 60,000

PREPAID RENT 60,000
DEPOSIT FOR RENT 80,000
LEASEHOLD IMPROVEMENT 360,000
CASH 560,000

DEPRECIATION EXP - LI 6,000

ACCU. DEP 6,000

Problem 4

On January 1, 2014, ABC company leased a delivery truck from Marr company under a three-year operating lease.
Total rent for the term of the lease is P3,600,000, payable as follows:

12 months at P50,000 ………………………………..P 600,000

12 months at P75,000 ……………………………….. 900,000
12 months at P175,000 ……………………………… 2,100,000 3,600,000 / 3 = 1,200,000

PAS 17: LEASES 6

All payments were made when due.

LESSEE LESSOR
RENT EXPENSE 1,200,000 CASH 600,000
CASH 600,000 RENT RECEIVABLE 600,000
RENT PAYABLE 600,000 RENT INCOME 1,200,000
RENT EXPENSE 1,200,000 CASH 900,000
CASH 900,000 RENT RECEIVABLE 300,000
RENT PAYABLE 300,000 RENT INCOME 1,200,000
RENT EXPENSE 1,200,000 CASH 2,100,000
RENT PAYABLE 900,000 RENT INCOME 1,200,000
CASH 2,100,000 RENT RECEIVABLE 900,000

Required: Prepare all indicated entries on the books of the lessor and lessee over the three year term.

ACCOUNTING FOR FINANCE LEASE: BOOK OF THE LESSEE

Items to be Recognized at the Commencement Date

After classifying the lease as finance lease, the lessee shall record an asset and lease liability equal to the fair
value of the leased property at the inception of the lease or the present value of the minimum lease
payments, whichever is lower.

Lease Liability to be Recognized

a) Initial valuation – the amount of liability to be recognized shall be equal to the unpaid portion of the
lower between present value of minimum lease payments or fair value of the leased asset at inception date.
b) Subsequent valuation - shall be measured at amortized cost using the effective interest method.

LEASED ASSET

Initial valuation of lease asset to be recognized

Cost of asset to be Acquisition cost of Fair value at

capitalized asset inception date

Lower
PV of minimum
lease payments

Other directly Initial direct costs

attributable cost paid by the lessee

Minimum Lease payments (MLP)

These are the payments over the lease term that the lessee is or can be required to make, excluding contingent
rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:

1. For a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or
2. For a lessor, any residual value guaranteed to the lessor by:
a. The lessee;
b. A party related to the lessee; or
c. A third party unrelated to the lessor that is financially capable of discharging the obligations under the
guarantee.

PAS 17: LEASES 7

Computation of minimum lease payments

If there is transfer of ownership or bargain purchase option

Total periodic rental payment

(Periodic rental payment x Lease term) XX

Add: Bargain Purchase option (if applicable) XX

Total minimum lease payments XX

If there is NO transfer of ownership or bargain purchase option

Total periodic rental payment

(Periodic rental payment x Lease term) XX

Add: Guaranteed residual value (if applicable) XX

Total minimum lease payments XX

NOTE: Guaranteed or unguaranteed residual value is IGNORED in the computation of minimum lease payments
when there is a transfer of ownership or bargain purchase option since the leased asset will not revert back to the
lessor.

RESIDUAL VALUE (Guaranteed vs Unguaranteed)

*Guaranteed residual value Unguaranteed residual value

Lessee’s point of view

 Guaranteed by the lessee or by a party related to  Guaranteed by a party other than the lessee or
the lessee party unrelated to the lessee

Lessor’s point of view

 Guaranteed by the lessee, party related to the  Realization of residual value is not assured or
lessee or any party who is financially capable of guaranteed by a party related to the lessor.
discharging the obligations under guarantee

*Note: Guaranteed residual value is the maximum amount that could, in any event, becomes payable at the end of
the lease term.

Present Value of the Minimum Lease Payments:

Present Value of periodic rental payment xxx

Add: Present value of guaranteed residual value (GRV x PV of 1) or

Present value of bargain purchase option (BPO x PV of 1) xxx

Present value of minimum lease payments xxx

Rate used in calculating present value

In calculating the present value of minimum lease payments, the following rate shall be used in order of priority:

Interest rate implicit in the lease, if this is practicable to determine.

PAS 17: LEASES 8

 The interest rate implicit in the lease is the discount rate that causes the aggregate present value of the minimum
lease payments and the unguaranteed residual value equal to the fair value of the leased asset and initial direct
costs of the lessor.
1. Lessee’s incremental borrowing rate
The lessee’s incremental borrowing rate is the rate of interest that the lessee would have to pay on a similar
lease, or the rate that the lessee would incur by borrowing funds to purchase the asset over a similar term and
similar security.

Subsequent valuation of leased asset

An entity shall measure the asset subsequently in accordance with PAS 16. In addition, an entity should observe the
following:

If there is transfer of ownership or bargain If there is NO transfer of ownership or bargain

purchase option purchase option

Life to be used:

Based on leased asset’s useful life Based on leased asset’s useful life or lease term,
whichever is shorter

Residual value:

Estimated amount expected to be realized upon Gross amount of guaranteed residual value, if
disposal of the asset at the end of its useful life applicable (asset reverts back to the lessor).

FINANCE LEASE - LESSEE

FINANCE Title of Depreciation Valuation of Executory Initial Direct

LEASE - ownership Leased Asset costs and cost
LESSEE contingent
rent

1.)Transfer of Transferred Cost – Salvage Lower between Expense Capitalizable

ownership at value FMV of leased as leased asset
the end of the asset or PV of
lease term EUL MLP

PAS 17: LEASES 9

 2.)The lessee Transferred Cost – Salvage Lower between Expense Capitalizable
has the bargain value FMV of leased as leased asset
purchase option asset or PV of
EUL MLP

3.)The lease Not transferred Cost – GSV Lower between Expense Capitalizable
term is for the FMV of leased as leased asset
major part of Shorter between asset or PV of
the economic lease term or MLP
life of the leased useful life
asset.

4.)The present Not transferred Cost – GSV Lower between Expense Capitalizable
value of the FMV of leased as leased asset
minimum lease Shorter between asset or PV of
payment lease term or MLP
amounts to useful life
substantially all
of the fair value
of the leased
asset

5.)Asset for Not transferred Cost – GSV Lower between Expense Capitalizable
lease is for an FMV of leased as leased asset
exclusive use of Shorter between asset or PV of
lessee lease term or MLP
useful life

LESSEE LESSOR
LEASED ASSET 455,000
FLO 455,000

ACTUAL PRICE 450,000 (UNKNOWN TO LESSEE)

FMV 475,000
PV OF MLP 455,000

RENTAL PAYMENT X PVF = CP (SP of LESSOR) INSTALLMENT PAYMENT X PVF = CASH PRICE
125,000 X 3.64 = 455,000 125,000 X 3.60 = 450,000
11.5% 12%

FINANCE LEASE – LESSEE

PROBLEM 1 (Transfer of ownership)

On January 1, 2014, an entity leases a machinery for 4 years which is the same as the useful life of the
machinery at annual rental of P100,000 payable at the end of each year. The lease provides for a
transfer of ownership of the leased asset to the lessee at the end of the lease term. Prepare the
necessary journal entries of the above transaction assuming that the implicit rate is 12%.

1/1/14 Leased asset 304,000 304,000/4

PAS 17: LEASES 10

 FLO 304,000

12/31/14 FLO 63,520

IE 36,480
Cash 100,000

12/31/14 Depreciation expense 76,000

Accu. Dep 76,000

12/31/15 FLO 71,142

IE 28,858
Cash 100,000

Dep. Exp 76,000

Accu. Dep 76,000

12/31/16 FLO 79,679

IE 20,321
Cash 100,000

Dep. Exp 76,000

Accu. Dep 76,000

12/31/17 FLO 89,659

IE 10,341
Cash 100,0000

Dep. Exp 76,000

Accu. Dep 76,000

FMV ?
PV OF MLP

PV OF RP 100,000 X 3.04 = 304,000

PV OF BPO/GSV 0 0

DATE PAYMENT INTEREST PRINCIPAL PV

12%
1/1/14 304,000
12/31/14 100,000 36,480 63,520 240,480
12/31/15 100,000 28,858 71,142 169,338
12/31/16 100,000 20,321 79,679 89,659
12/31/17 100,000 10,341 89,659 0

PROBLEM 2 (With BPO)

Lessee Company leased a machine on January 1, 2014 with the following pertinent information:

Annual rental payable at the end of each year P1,000,000

Lease term 10 years
Useful life of machine 12 years
Incremental borrowing rate of lessee 14%
Implicit interest rate of lessor known to lessee 12%

PAS 17: LEASES 11

Lessee Company has the option to purchase the machine upon the lease expiration on January 1, 2024
by paying P500,000 which is sufficiently lower that the expected fair value of the machine on January 1,
2024. At the inception of the lease, the bargain purchase option is reasonably certain to be excercised.
The estimated residual value of the machine at the end of its 12-year life is P600,000. Prepare the
necessary journal entries of the above transaction.

1/1/14 Leased asset 5,810,000 (5,810,000 - 600,000)/ 12

FLO 5,810,000

12/31/14 FLO 302,800

IE 697,200
Cash 1,000,000

Depreciation exp 434,167

Accu. Dep 434,167

12/31/15

FMV ?
PV OF MLP 5,810,000

PV OF PR 1,000,000 X 5.65 = 5,650,000

PV OF BPO/GSV 500,000 X .32 = 160,000

DATE PAYMENT INTEREST PRINCIPAL PV

12%
1/1/14 5,810,000
12/31/14 1M 697,200 302,800 5,507,200
12/31/15 1M 660,864 339,136 5,168,064
12/31/16 1M 620,168 379,832 4,788,232
12/31/17 1M 574,588 425,412 4,362,820
12/31/18 1M 523,538 476,462 3,886,358
12/31/19 1M 466,363 533,637 3,352,721
12/31/20 1M 402,327 597,673 2,755,048
12/31/21 1M 330,606 669,394 2,085,654
12/31/22 1M 250,278 749,722 1,335,932
12/31/23 1M 164,068 835,932 500,000
1/1/24 500K 0 500,000 0

1/1/24 FLO 500,000

Cash 500,000

PROBLEM 3 (With GSV)

Easy Company leased an equipment on January 1, 2014 with the following information:

Annual rental payable at the end of each lease year P1,000,000

Lease term 4 years
Useful life of equipment 4 years
Implicit interest rate 10%

Easy company has guaranteed a P200,000 residual value on December 31, 2017 to the lessor. The
equipment will revert to the lessor upon the expiration of the lease on December 31, 2017. Prepare the
necessary journal entries of the above transaction.
PAS 17: LEASES 12
1/1/14 Leased asset 3,306,000 (3,306,000 - 200,000)/4
FLO 3,306,000

12/31/14 FLO 669,400

IE 330,600
Cash 1,000,000

Depreciation exp. 776,500

Accu. Dep 776,500

FMV ?
PV OF MLP 3,306,000

PV OF PR 1,000,000 X 3.17 = 3,170,000

PV OF BPO/GSV 200,000 X .68 = 136,000

DATE PAYMENT INTEREST PRINCIPAL PV

10%
1/1/14 3,306,000
12/31/14 1M 330,600 669,400 2,636,600
12/31/15 1M 263,660 736,340 1,900,260
12/31/16 1M 190,026 809,974 1,090,286
12/31/17 1M 109,714 890,286 200,000
12/31/17 200K 0 200k 0

12/31/17 Loss from FL 50,000

FLO 200,000
Accu. Dep 3,106,000
Leased asset 3,306,000
Cash 50,000

Leased asset 3,306,000

AD (776,500 X 4) 3,106,000
200,000

PROBLEM 4 (With initial direct cost and GSV)

Simple Company leased an equipment on January 1, 2014 with the following information:

Annual rental payable at the end of each lease year P1,000,000

Initial direct cost paid on January 1, 2014 100,000
Lease term 5 years
Useful life of Equipment 6 years
Implicit interest rate 8%

PAS 17: LEASES 13

The entity has guaranteed a P300,000 residual value on January 1, 2019 to the lessor. The equipment
will revert to the lessor upon the lease expiration on January 1, 2019. Prepare the necessary journal
entries of the above transaction.

1/1/14 Leased asset 4,194,000

FLO 4,194,000

Leased asset 100,000

Cash 100,000

12/31/14 FLO 664,480

IE 335,520
Cash 1,000,000

Depreciation exp 798,800

Accu. Dep. 798,800

(4,294,000 - 300,000)/5

FMV ?
PV OF MLP 4,194,000

PV OF PR (1,000,000 X 3.99) 3,990,000

PV OF BPO/GSV (300,000 X .68) 204,000

DATE PAYMENT INTEREST PRINCIPAL PV

8%
1/1/14 4,194,000
12/31/14 1M 335,520 664,480 3,529,520
12/31/15 1M 282,362 717,638 2,811,882
12/31/16 1M 224,951 775,049 2,036,833
12/31/17 1M 162,947 837,053 1,199,780
12/31/18 1M 100,220 899,780 300,000
1/1/19 300K 0 300,000 0
1/1/19 FLO 300,000
Accu dep 3,994,000
Leased asset 4,294,000

Leased asset 4,294,000

AD 798,800 X 5 3,994,000
300,000

LEASE OF LAND AND BUILDING

Lease of land and building are considered separately for the purpose of lease clarification.

Generally, a lease of land will be regarded as an operating lease unless the title passes to the lessee. But even
there is no transfer of title, a lease of land may be accounted for as a finance lease if the lease extends to a relatively
very long period of time.

If the land and building are accounted for as finance lease, use the following:
With relative fair value Allocate the minimum lease payments (including any lump-sum upfront
payments) to the land and building using relative fair value method.

No reliable allocation bases Account the land and building as a single item under a finance lease.

PAS 17: LEASES 14

 Land is immaterial Account the land and building as a single item under a finance lease. In
this case, the economic life of the buildings is regarded as the economic
life of the entire leased asset.

If the land and building are accounted for as operating lease, a recording of the rent expense is made at the time it is
incurred.

Land and building as Investment property

Fair value model is to be used. Account the land and building as a single item under a finance lease since
no depreciation is to be recorded on the building.

Cost model is to be used. Allocate the minimum lease payment to the land and building using relative
fair value method.

ACCOUNTING FOR FINANCE LEASE: BOOK OF THE LESSOR

FINANCE LEASE-LESSOR
a. Direct financing lessor
b. Sales type lease

Types: Direct Financing lease Sales type lease

Definition Does not involve a manufacturer’s or dealer’s Involves the recognition of a

profit manufacturer’s or dealer’s profit or loss
on the transfer of the asset to the lessee

Initial direct cost Included in the initial measurement of the net Expensed immediately (or added to the
lease receivable or net investment cost of sales account.)

Effect if there is New implicit rate will be computed using

initial cost interpolation. (Note that the PV is higher thus
the new implicit rate is lower than the old
implicit rate.)

Gross investment in the lease is the total of the minimum lease payments receivable by the lessor under a finance
lease plus any unguaranteed residual value accruing to the lessor. This figure is actually the amount debited to the
lease receivable.

Net investment in the lease is equal to the gross investment less unearned finance income or the gross investment in
the lease discounted at the interest rate implicit in the lease.

Manufacturer’s or dealer’s profit is the difference between the present value of the minimum lease payments and
the cost of the leased asset.

Summary of Journal Entries

LESSEELESSOR

Sales Type Lease

Direct-financing lease Lease receivable xx
Lease receivable xx Unearned int. income xx
1. Inception of the Lease
Unearned int. income xx Sales xx
Lease Assetxx
Leased Asset xx
Lease Liability xx
Cost of Sales xx
MerchandisePASInventory xx 15
17: LEASES

Initial direct cost (exp) xx

Leased Assetxx Cash xx
2. Initial direct cost
Cashxx
Incurred by the lessor
 Cashxx Cash xx
3. Payment by the Lessee or
Lease Receivable xx Lease receivable xx
Receipt by the lessor
Payment Liability xx
Unearned int. income xx Unearned int. income xx
Interest Expense xx
Interest incomexx Interest income xx
Cash xx FINANCE LEASE - LESSOR
4. to record depreciation of
The leased asset
No journal Entry
Depreciation Expense xx
Acc. Depreciation xx No journal Entry
(A) dr. FLR (B) cr. (A)-(B) cr. UII
Leased
5. Expiration under Guaranteed residual
assetvalue: Fair value is equal to residual value
Direct Gross Net Unearned Initial Direct Executory Sales Cost of
Financing
Lease Liability xx Investment Investment Leased Assetxx
Interest Cost costs
Inventoryxx (NET Sales
Lease
Acc. Depreciation xx (FMV of Lease receivable
Income xx Lease receivable xx
leased
INVESTM
Leased Assetxx ENT)
asset, PV of
MLP and CV
6. Expiration under Guaranteed residual value: Fair value is less than to residual value
of leased
asset)
Lease Liability
Transfer of xx MLP PV of MLP LeasedAmortized UII xx Expense
Inventoryxx PV of
Assetxx Cost of
Acc. Depreciation
ownership xx PP PV of PPCashxx over the lease Cash xx
Cashxx MLP the
Leased Assetxx
to the Plus Plus Leaseterm using xx
receivable Plus xx asset
Lease receivable
Loss on finance
buyer lease BPOxx PV of BPO effective
Cash xx method of PV of BPO
amortization.
No MLP PV of MLP Amortized UII xx Expense PV of Cost of
Transfer PP PV of PP over the lease Cash xx
7. Expiration under Unguaranteed residual value: Fair value is less than to residual value MLP the
(Revert Plus Plus term using
Back) BPO or GSV PV of BPO effective
Plus asset
Lease Liability xx or UGSV or GSVLeased
or Asset
method of xx PV of BPO Minus
Inventoryxx
Acc. Depreciation xx UGSV Loss onamortization.
finance lease xx Loss on Sales typeorleasexx
or GSV PV of
Leased Assetxx Lease receivable xx Lease receivable xx UGSV
UGSV
Sales type (A) dr. LR (A)-(B) cr. UII COS xx Expense
Lease Same as Same as Cash xx
above above

Machinery 100,000 Machinery 100,000

Cash 100,000 Cash 100,000

Machinery 10,000 UII 10,000

Cash 10,000 Cash 10,000

FLR 150,000 FLR 150,000

Machinery 110,000 Machinery 100,000

UII 40,000 Uii 50,000

MACHINERY 0 MACHINERY 0

FLR 150,000 FLR 150,000

LESS UII 40,000 110,000 UII 40,000 110,000

PAS 17: LEASES 16

DIRECT FINANCING

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT PV OF PERIODIC PAYMENT G.I - N.I
BPO/GSV/UGSV PV OF BPO/GSV/UGSV

SALES TYPE
G.I N.I U.I.I
FLR LEASED ASSET
PERIODIC PAYMENT PV OF PERIODIC PAYMENT G.I - N.I
BPO/GSV/UGSV PV OF BPO/GSV/UGSV

SALES COST OF SALES

PV OF PERIODIC PAYMENT COST OF INVENTORY
PV OF BPO/GSV LESS PV OF UGSV

LESSOR- DIRECT FINANCING LEASE

Example 1 (Direct financing lease with no guaranteed or unguaranteed residual value)

On January 1, 2012, XYZ Corporation leased a machine to ABC Company for a five-year period requiring
payments of P100,000 at the beginning of each lease year. The machine cost P417,000 which is the fair value at the
lease date. The machine has a useful life of five years with no residual value. XYZ Corporation’s implicit interest
rate is 10%. XYZ Corporation appropriately recorded the lease as a direct financing lease. Prepare the necessary
journal entries of the above transactions.

1/1/12 Machinery 417,000

Cash 417,000

1/1/12 FLR 500,000

Machinery 417,000
UII 83,000

1/1/12 Cash 100,000

FLR 100,000

12/31/12 UII 31,700

II 31,700

1/1/13 Cash 100,000

FLR 100,000

12/31/13 UII 24,870

II 24,870

1/1/14 Cash 100,000

FLR 100,000

100,000 x 4.17 =

PAS 17: LEASES 17

 G.I N.I U.I.I
FLR LEASED ASSET
PERIODIC PAYMENT 100,000 x 5 PV OF PERIODIC PAYMENT G.I - N.I
500,000 417,000
BPO/GSV/UGSV PV OF BPO/GSV/UGSV 0
0

83,000
500,000 417,000

DATE COLLECTION INTEREST PRINCIPAL PV

10%
1/1/12 417,000
1/1/12 100,000 - 100,000 317,000
1/1/13 100,000 31,700 68,300 248,700
1/1/14 100,000 24,870 75,130 173,570
1/1/15 100,000 17,357 82,643 90,927
1/1/16 100,000 9,073 90,927 0

Example 2 (Direct financing lease with guaranteed residual value)

On December 31, 2012, XYZ Corporation leased a machine to ABC Company for a five-year period
requiring payments of P100,000 every December 31. The first periodic payment is due December 31, 2012. The
machine cost P466,600, which is the fair value at the commencement date. The machine has a useful life of six
years with P80,000 residual value guaranteed by the lessee at the end of the lease term. XYZ Corporation’s implicit
rate is 10%. XYZ Corporation appropriately recorded the lease as a direct financing lease. Prepare the necessary
journal entries of the above transactions.

12/31/12 Machinery 466,600

Cash 466,600

12/31/12 FLR 580,000

Machinery 466,600
UII 113,400

12/31/12 Cash 100,000

FLR 100,000

12/31/13 UII 36,660

II 36,660

12/31/13 Cash 100,000

FLR 100,000

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT 100k x 5 PV OF PERIODIC PAYMENT G.I - N.I
500,000 PV OF BPO/GSV/UGSV
BPO/GSV/UGSV
80,000

113,400
580,000 466,600

PAS 17: LEASES 18

 DATE COLLECTION INTEREST PRINCIPAL PV
10%
12/31/12 466,600
12/31/12 100,000 - 100,000 366,600
12/31/13 100,000 36,660 63,340 303,260
12/31/14 100,000 30,326 69,674 233,586
12/31/15 100,000 23,359 76,641 156,945
12/31/16 100,000 15,695 84,305 72,640
12/31/17 80,000 7,360 72,640 0

12/31/17 UII 7,360

II 7,360

Machinery 80,000
FLR 80,000

Example 3 (Direct financing lease with unguaranteed residual value)

Assume that in the preceding case, the residual value of P80,000 at the end of the five-year lease term is
unguaranteed by the lessee. Prepare the necessary journal entries of the above transactions.

DATE COLLECTION INTEREST PRINCIPAL PV

1/1/12
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17

Example 4 (Direct financing lease with initial direct cost)

On December 31, 2012, XYZ Corporation leased a machine to ABC Company for a five-year period
requiring payments of P120,000 every December 31. The first periodic payment is due December 31, 2012. The
machine cost P450,000 which is the fair value at the commencement date. The machine has a useful life of five-
years, with no expected residual. Initial direct cost incurred in consummating this lease is P34,500. XYZ Corporation
appropriately recorded the lease as a direct financing lease. Prepare the necessary journal entries of the above
transactions.

12/31/12 Machinery 450,000

Cash 450,000

UII 34,500
Cash 34,500

FLR 600,000
Machinery 450,000
UII 150,000

12/31/12 Cash 120,000

FLR 120,000

12/31/13 UII 43,740

II 43,740

Cash 120,000
PAS 17: LEASES 19
 FLR 120,000

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT 120,000 x 5 PV OF PERIODIC PAYMENT G.I - N.I
600,000 PV OF BPO/GSV/UGSV
BPO/GSV/UGSV
0

150,000
600,000 450,000

DATE COLLECTION INTEREST PRINCIPAL PV

12%
12/31/12 484,500
12/31/12 120,000 - 120,000 364,500
12/31/13 120,000 43,740 76,260 288,240
12/31/14 120,000
12/31/15 120,000
12/31/16 120,000

120, 000 X 4.0375 = 484,500

1/? ^4-1 / ? +1 = 4.0375

10%

PAS 17: LEASES 20

 FINANCE LEASE - LESSOR

(A) dr. FLR (B) cr. (A)-(B) cr. UII

Leased
asset
Direct Gross Net Unearned Initial Direct Executory Sales Cost of
Financing Investment Investment Interest Cost costs (NET Sales
Lease (FMV of Income
leased
INVESTM
asset, PV of ENT)
MLP and CV
of leased
asset)
Transfer of MLP PV of MLP Amortized UII xx Expense PV of Cost of
ownership PP PV of PP over the lease Cash xx MLP the
to the Plus Plus term using
buyer BPO PV of BPO effective
Plus asset
method of PV of BPO
amortization.
No MLP PV of MLP Amortized UII xx Expense PV of Cost of
Transfer PP PV of PP over the lease Cash xx MLP the
(Revert Plus Plus term using
Back) BPO or GSV PV of BPO effective
Plus asset
or UGSV or GSV or method of PV of BPO Minus
UGSV amortization. or GSV or PV of
UGSV UGSV
Sales type (A) dr. LR (A)-(B) cr. UII COS xx Expense
Lease Same as Same as Cash xx
above above

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT PV OF PERIODIC PAYMENT G.I - N.I
BPO/GSV/UGSV PV OF BPO/GSV/UGSV

SALES COST OF SALES

PV OF PERIODIC PAYMENT COST OF INVENTORY
PV OF BPO/GSV LESS PV OF UGSV

INVENTORY 100,000
DM XXX
DL XXX
FOH XXX

FLR XXX
COS XXX
SALES XXX
UII XXX
INVENTORY 100,000

PAS 17: LEASES 21

 12 months 10 months
Sales 1,000 X 12 12,000 10,000
COS 750 X 12 9,000 7,500
GP 3,000

LESSOR- DEALER’S LEASE OR MANUFACTURER’S LEASE

Example 1 (Dealer’s lease or manufacturer’s lease with costs directly attributable to

negotiating and arranging a lease)

XYZ Mfg. Company uses lease as a means of selling the equipment that it manufactures. The company uses a
perpetual inventory system. On January 1, 2012, the company leased a machine to ABC Company. The cost of the
machine to XYZ was P784,500. On January 1, 2012, XYZ Mfg. Company paid P20,000 in connection with negotiating
and arranging the lease. The fair market value (which was the sales price) was P1,108,250 at the time of the lease.

Annual lease payments are P250,000 and are payable in advance for 6 years. The first payment is made on January
1, 2012 and subsequent payments are to be made at the end of each year beginning December 31, 2012.

At the end of the lease term, title to the machine will pass to ABC. The lessor’s implicit rate is 14% and the lessor
uses the calendar year. Prepare the necessary journal entries of the above transactions.

1/1/12 INVENTORY 784,500

DM XXX
DL XXX
FOH XXX

COS 20,000
CASH 20,000

FLR 1,500,000
COS 784,500
SALES 1,108,250
UII 391,750
INVENTORY 784,500

1/1/12 CASH 250,000

FLR 250,000

12/31/12 UII 120,155

II 120,155

CASH 250,000
FLR 250,000

250,000 X 4.433 = 1,108,250

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT 250K X 6 PV OF PERIODIC PAYMENT 1,108,250 G.I - N.I
1,500,000 PV OF BPO/GSV/UGSV 0
BPO/GSV/UGSV
0

391,750
1,500,000 1,108,250

SALES COST OF SALES

PV OF PERIODIC PAYMENT 1,108,250 COST OF INVENTORY 784,500
PV OF BPO/GSV 0 LESS PV OF UGSV 0

PAS 17: LEASES 22

 784,500
1,108,250

DATE COLLECTION INTEREST PRINCIPAL PV

14%
1/1/12 1,108,250
1/1/12 250,000 0 250,000 858,250
12/31/12 250,000 120,155 129,845 728,405
12/31/13 250,000 101,977 148,023 580,382
12/31/14 250,000 81,253 168,747 411,635
12/31/15 250,000 57,629 192,371 219,264
12/31/16 250,000 30,736 219,264 0

Example 2 (Dealer’s lease or manufacturer’s lease with unguaranteed residual value)

XYZ Mfg. Company uses lease as a means of selling the equipment that it manufactures. The company uses a
perpetual inventory system.

On January 1, 2012, the company leased a machine to ABC Company. The cost of the machine to XYZ was
P850,000. The machine is expected to have an unguaranteed residual value of P100,000 at the end of the lease
term of 6 years. The machine has an estimated useful life of 7 years.

Annual lease payments are P250,000 payable at the end of each year beginning December 31, 2012. XYZ Mfg.
Company is a calendar year corporation. The rate implicit in the lease is 10%. Prepare the necessary journal entries
of the above transactions.

1/1/12 INVENTORY 850,000

DM XXX
DL XXX
FOH XXX

FLR 1,600,000
COS 850,000
SALES 1,146,000
UII 454,000
INVENTORY 850,000

12/31/12 UII 114,600

II 114,600

CASH 250,000
FLR 250,000

Pv of mlp 250,000 x 4.36 = 1,090,000

Pv of ugsv 100,000 x .56 = 56,000

G.I N.I U.I.I

FLR LEASED ASSET
PERIODIC PAYMENT 250k x 6 PV OF PERIODIC PAYMENT 1,090,000 G.I - N.I
1,500,000 PV OF BPO/GSV/UGSV
BPO/GSV/UGSV 56,000
100,000

454,000
1,600,000 1,146,000

SALES COST OF SALES

PAS 17: LEASES 23

 PV OF PERIODIC PAYMENT COST OF INVENTORY 850,000
1,090,000 LESS PV OF UGSV
PV OF BPO/GSV
56,000

850,000
1,146,000

DATE COLLECTION INTEREST PRINCIPAL PV

10%
1/1/12 1,146,000
12/31/12 250,000 114,600 135,400 1,010,600
12/31/13 250,000 101,060 148,940 861,660
12/31/14 250,000 86,166 163,834 697,826
12/31/15 250,000 69,783 180,217 517,607
12/31/16 250,000 51,761 198,239 319,368
12/31/17 250,000 30,632 219,368 100,000
12/31/17 100,000 - 100,000 0

LOSS 20,000
12/31/17 INVENTORY 80,000
FLR 100,000

Example 3 (Dealer’s lease or manufacturer’s lease with guaranteed residual value)

Assume exactly the same facts as in example 2, except that the lessee guarantees the residual value of P100,000 at
the end of the lease term. Prepare the necessary journal entries of the above transactions.

DATE COLLECTION INTEREST PRINCIPAL PV

1/1/12
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17

PAS 17: LEASES 24

SALES AND LEASEBACK
SALES AND LEASEBACK FINANCE LEASE (GOT TO BELIEVE IN MAGIC)

SALES AND LEASEBACK OPERATING (STARTING OVER AGAIN)

Sale and Leaseback is an arrangement whereby one party sells a property to another party and then
immediately lease the property back from its new owner. Thus, the seller becomes a seller-lessee and the
purchaser, purchaser-lessor.

Summary of Accounting Treatments

Leaseback as a Finance lease

Selling price or proceeds

From the sale Difference is treated as follows:
SP > CA (Deferred gain to be
Amortized over the lease term)
SP < CA (Loss to be recognized
As part of P/L for the period.
Carrying amount of the
Leased Asset

Leaseback as an Operating Lease

For leaseback as an operation lease, the following rules should be observed:

CASE NO.1: Carrying amount > Selling price = Fair value

Carrying amount

Outright Loss – P&L

Selling price = Fair Value

CASE NO. 2: Selling price = Fair value > Carrying amount

Selling price = Fair Value

Gain on sale on leaseback – P&L

Carrying amount

CASE NO. 3: Selling price > Fair value > Carrying amount

PAS 17: LEASES 25

 Selling price
Deferred gain on sale on leaseback

Fair value
Gain on sale on leaseback – P&L

Carrying amount

CASE NO. 4: Fair value > Selling price > Carrying amount

Selling price
Ignore

Fair value
Gain on sale on leaseback – P&L

Carrying amount

Notes:
 Deferred gain- the amount of deferred gain will be amortized over the lease term and/or will be
derecognize when asset is disposed.
 Loss is deferred if such loss is compensated by future lease payments below market value. Any
loss deferred is amortized over which the asset is expected to be used.

(SP = FMV) > CV ----------------- OUTRIGHT GAIN

100 = 100 > 75 ----------------- 25,000

(SP = FMV) < CV ----------------- OUTRIGHT LOSS

100 = 100 < 125 --------------- 25,000

(SP > FMV) ----------------- DEFERRED GAIN

100 > 90 --------------------------- 10
FMV > CV ----------------- OUTRIGHT GAIN
90 > 85 ------------------ 5

(SP > FMV) ----------------- DEFERRED GAIN

100 > 90 -------------------------- 10
FMV < CV ----------------- OUTRIGHT LOSS
90 < 95 ------------------ 5

(SP < FMV) ------------------ IGNORE

100 < 125 ------------------------
FMV > CV ------------------ OUTRIGHT GAIN
80 ------------------ 20

(SP < FMV) ------------------ IGNORE

100 < 125
FMV < CV ------------------ OUTRIGHT LOSS
110 ---------------- 10

PAS 17: LEASES 26

* (SP < FMV) ------------------ DEFERRED LOSS
100 < 120 ------------------ 20

RENT EXPENSE 30 ------ 20

CASH 100
DL 20
EQUIPMENT 120

RE 20
CASH 20

LOSS 10
DL 10

* Loss is deferred if such loss is compensated by future lease payments below market value. Any loss
deferred is amortized over which the asset is expected to be used.

SALE AND LEASEBACK

PROBLEM 1 (FINANCE LEASE)

On January 1, 2012, ABC Company sold equipment with a recorded cost of P600,000 and a carrying value of P375,000 to XYZ
Corporation for P475,000 and immediately leases back the equipment. The lease is non-cancelable for 5 years and requires
payment of P110,000 in advance at the beginning of each year. The implicit rate is 10%.

The equipment has a fair value of P475,000 on January 1, 2012 and an estimated remaining life of 8 years. ABC uses straight line
depreciation for all its depreciable assets. Title passes to the lessee at the end of the lease term.

SP 475,000
CV 375,000

1/1/12 CASH 475,000

EQUIPMENT 375,000
DG 100,000/5

1/1/12 EQUIPMENT 458,700 (458,7000 - 0)/ 8

FLO 458,700

12/31/12 DEP 57,337.50

AD 57,337.50

DG 20,000
GAIN ON S/L 20,000

PAS 17: LEASES 27

FMV 475,000
PV OF MLP 458,700

PV OF PR 110,000 X 4.17 = 458,700

PV OF BPO/GSV

PROBLEM 2 (Operating Lease)

On January 1, 2012, ABC Company sold a machinery with a remaining life of 5 years for P350,000 which is equal to its fair value.
On the same date, ABC leased back the equipment for 2 years at an annual rental of P100,000 payable at the end of each year.

The equipment is carried in the books of ABC at a cost of P600,000 with an accumulated depreciation of P325,000. The interest
rate implicit in the lease is 10%.

SP 350,000
FMV 350,000
CV 275,000

CASH 350,000
AD 325,000
MACHINERY 600,000
GAIN ON S/L 75,000

RENT EXPENSE 100,000

CASH 100,000

PROBLEM 3 (Operating Lease)

On January 1, 2012, ABC Company sold a machinery with a remaining life of 5 years for P350,000. On the same date, ABC leased
back the equipment for 2 years at an annual rental of P100,000 payable at the end of each year.

The equipment is carried in the books of ABC at a cost of P600,000 with an accumulated depreciation of P325,000 and a fair
value of P280,000. The interest rate implicit in the lease is 10%.

SP 350,000
FMV 280,000
CV 275,000

CASH 350,000
AD 325,000
MACHINERY 600,000
DG 70,000
GAIN ON SL/L 5,000

RENT EXPENSE 100,000

CASH 100,000

DG 35,000
GAIN ON S/B 35,000

PAS 17: LEASES 28

 PROBLEM 4 (Operating Lease)

On January 1, 2012, ABC Company sold a machinery with a remaining life of 5 years for P250,000. On the same date, ABC leased
back the equipment for 2 years at an annual rental of P100,000 payable at the end of each year.

The equipment is carried in the books of ABC at a cost of P600,000 with an accumulated depreciation of P325,000 and a fair
value of P280,000. The interest rate implicit in the lease is 10%.

SP 250,000
FMV 280,000
CV 275,000

CASH 250,000
LOSS 25,000
AD 325,000
EQUIPMENT 600,000

RENT EXPENSE 100,000

CASH 100,000

PROBLEM 5 (Operating Lease)

On January 1, 2012, ABC Company sold a machinery with a remaining life of 5 years for P250,000. On the same date, ABC leased
back the equipment for 2 years at an annual rental of P85,000 payable at the end of each year.

The equipment is carried in the books of ABC at a cost of P600,000 with an accumulated depreciation of P325,000 and a fair
value of P280,000. The interest rate implicit in the lease is 10%. A fair annual rental for the asset is P100,000.

SP 250,000
FMV 280,000
CV 275,000

CASH 250,000
DL 30,000
AD 325,000
EQUIPMENT 600,000
GAIN ON S/L 5,000

RENT EXPENSE 85,000

CASH 85,000

LOSS ON S/L 15,000

DL 15,000

PAS 17: LEASES 29