LEASES

RELATED STANDARDS: IFRS 16 Leases

OPERATING LEASE

Measurement
✓ Lease payments under an operating lease shall be recognized as an expense on a straight-line
basis over the lease term unless another systematic basis is more representative of the time pattern
of the user’s benefit.

Summary of lease related payments:

Payments Accounting Treatment
Periodic rent payment Recognized as expense/income on a straight-line basis (Recognize
uniform amount even if unequal rental payments)
Contingent rent Additional rental payment based other factors other than passage of time.
Recognized as expense/income for the period as earned/incurred. (i.e. %
of sales, price index, market rate)
Lease bonus Deferred rent to be amortized over lease term
Security deposit Liability by lessor/Receivable by lessee (refundable upon lease expiration)
First month’s rent Recognized as expense/income for the 1st month of rental period.
Last month’s rent Deferred rent
Leasehold improvement Depreciated over lease term or useful life whichever is shorter. Residual
value is ignored.
Initial direct cost Added to the carrying amount of leased asset and recognized as expense
over the lease term by the lessor. (Directly attributable to negotiating and
arranging the lease)
Executory costs Lessor normally bears the executory costs as expense. If passed on to
lessee, lessee recognized such payment as expense. (i.e. depreciation of
leased asset, maintenance, insurance and real property taxes)

✓ Example: On January 1, Year 1, LESSOR leased a small store to LESSESS for 3 years. Rental
payment will be: P20,000 per month for the first year, P30,000 for the 2nd year and P40,000 for the
3rd year. Additional 5% rent for sales up to P1 million and 1% in excess of P1 million sales. LESSEE
generated P2 million sales in Year 1. The store building has a carrying amount of P1,500,000
remaining life of 15 years and no salvage value.
LESSOR incurred the following costs:
Initial direct costs 60,000
Maintenance cost on leased asset 10,000
LESSEE made the following payments on the inception of the lease:
Lease bonus 60,000
First month’s rent 20,000
Last month’s rent 40,000
Security deposit 40,000
Real property tax 10,000
Additions & improvements to leased asset (4-year life) 120,000
Residual value of additions and improvements 10,000

Requirements: Compute the following items that will appear in the Dec. 31, Year 1 financial
statements:
LESSOR LESSEE
1. Rental income 1. Rent expense
2. Depreciation expense 2. Depreciation expense
3. Total expenses related to the lease 3. Total expenses related to the lease
4. Carrying amount of leased asset 4. Total deferred amount
 DIRECT FINANCE LEASE – LESSEE

Present Value Computation of Minimum Lease Payments

Particular PV Computation
Periodic rental payment Use PV of ordinary annuity or annuity in advance
Bargain purchase option Use PV of 1
Guaranteed residual value Use PV of 1
Unguaranteed residual Excluded from PV of minimum lease payments
value
Executory costs Excluded from PV of minimum lease payments
Contingent rent Excluded from PV of minimum lease payments
Initial direct cost Part of leased asset but not part of lease liability (Valued at cost)

Computation of the PV of lease liability

PV of Gross rentals P xx
Add: PV of Residual value or bargain purchase option xx
Lease liability P xx
Note: Residual value is added only if the leased asset will revert to the lessor. Unguaranteed
residual value is ignored.

Computation of the leased asset

Lease liability as computed above P xx
Add: Initial direct cost xx
Capitalized leased asset P xx

Depreciation of Leased Asset

Particular Depreciable Amount Life
Ownership not transferred to lessee Amount capitalized as leased Shorter between useful life
(Unguaranteed residual value) asset (residual value ignored) and lease term
Ownership not transferred to lessee Amount capitalized as leased Shorter between useful life
(Guaranteed residual value) asset minus Residual value and lease term
Transfer of title to lessee or with bargain Amount capitalized as leased Useful life
purchase option to be exercised asset minus residual value

CASE A: Title will be transferred to the lessee (End of year payment)

Commencement of lease Jan. 01, 2017
Annual rent P 100,000.00
Lease term 3 years
Executory cost 20,000.00
Useful life of equipment 4 years
Initial direct cost 60,000.00
Implicit interest rate 10%
Residual value 50,000.00

PV of 1 at 10% for 3 periods 0.75131

PV of an ordinary annuity of 1 at 10% for 3 periods 2.48685
PV of an annuity due of 1 at 10% for 3 periods 2.73554

Date Payment Interest Principal PV

01/01/2017
12/31/2017
12/31/2018
12/31/2019
1. Lease asset and leased liability on January 1, 2017
2. Interest expense for the year 2017
3. Carrying amount of lease liability as of December 31, 2017
4. Annual depreciation
5. Carrying amount of equipment as of December 31, 2017

CASE B: Title will revert to the lessor (Guaranteed residual value & beginning of year payment)
Date Payment Interest Principal PV
01/01/2017
01/01/2017
01/01/2018
01/01/2019
01/01/2020
1. Interest expense for the year 2018
2. Carrying amount of lease liability as of December 31, 2018
3. Annual depreciation
4. Journal entry when fair value at the end of lease term is P60,000
5. Journal entry when fair value at the end of lease term is P40,000

CASE C: Lease with bargain purchase option of P30,000 (End of year payment)
Date Payment Interest Principal PV
01/01/2017
12/31/2017
12/31/2018
12/31/2019
1. Interest expense for the year 2019
2. Carrying amount of lease liability as of December 31, 2019
3. Interest expense for the year 2019
4. Annual depreciation
5. Journal entry when bargain purchase option is exercised
6. Journal entry when bargain purchase option is not exercised

FINANCE LEASE – LESSOR (DIRECT FINANCE LEASE)

Classification Lessor Income Recognized

Direct finance lease Financing business Interest income

Computation of periodic rentals

Net investment in the lease* xx
Less: Present value of residual value (guaranteed/unguaranteed) xx
PV of periodic rentals P xx
Divided by PV factor of ordinary annuity/annuity due ÷ xx
Periodic rental P xx
Note: Residual value is ignored if the ownership of leased asset will be transferred to lessee.

*Computation of Net Investment in the Lease

Cost of leased asset P xx
Add: Initial direct cost incurred by lessor xx
Net investment in the lease P xx
Note: Net investment in the lease is the amount credited to lease asset.

CASE D: Title will revert to the lessor (End of year collection and unguaranteed residual value)
 Commencement of lease Jan. 01, 2017
Cost of equipment P 500,000.00
Lease term 3 years
Executory cost 20,000.00
Useful life of equipment 4 years
Initial direct cost 34,936.00
Implicit interest rate 10%
Residual value 50,000.00

PV of 1 at 10% for 3 periods 0.75131

PV of an ordinary annuity of 1 at 10% for 3 periods 2.48685
PV of an annuity due of 1 at 10% for 3 periods 2.73554

Date Collection Interest Principal PV

01/01/2017
12/31/2017
12/31/2018
12/31/2019
1. Interest income for the year 2017
2. Carrying amount of lease receivable as of December 31, 2017
3. Journal entry for return of asset when fair value of the leased asset is P35,000?

CASE E: Title will revert to the lessor (Beginning of year collection and guaranteed residual value)
Same data above, except for
Cost of equipment P350,000.00
Initial direct cost incurred by lessor 15,831.00

Date Collection Interest Principal PV

01/01/2017
01/01/2017
01/01/2018
01/01/2019
01/01/2020
1. Interest income for the year 2018
2. Carrying amount of lease receivable as of December 31, 2018
3. Journal entry for return of asset when the fair value of the leased asset is P35,000?

FINANCE LEASE – LESSOR (SALES TYPE LEASE)

Classification Lessor Income Recognized

Sales type lease Manufacturer or dealer Manufacturer/dealer’s profit/loss (gross profit) and interest income

Computation of the PV of lease receivable and sales

PV of Gross rentals P xxx
Add: PV of Residual value or bargain purchase option xxx
Lease receivable/Sales P xxx
Note: Residual value is added only if the leased asset will revert to the lessor.
For sales computation unguaranteed residual value is ignored.

Computation of Cost of Goods Sold

Cost of leased asset P xxx
 Add: Initial direct cost (if any) xxx
Cost of Goods sold P xxx
Note: PV of unguaranteed residual value is deducted from cost of goods sold.

CASE F: Title will be transferred to the lessee (Beginning of year collection)

Commencement of lease Jan. 01, 2017
Cost of equipment P 200,000.00
Lease term 3 years
Annual rent 100,000.00
Useful life of equipment 4 years
Initial direct cost 60,000.00
Implicit interest rate 10%
Residual value 50,000.00

PV of 1 at 10% for 3 periods 0.75131

PV of an ordinary annuity of 1 at 10% for 3 periods 2.48685
PV of an annuity due of 1 at 10% for 3 periods 2.73554

Date Collection Interest Principal PV

01/01/2017
01/01/2017
01/01/2018
01/01/2019
01/01/2020
1. Gross profit
2. Interest income for the year 2018
3. Carrying amount of lease receivable as of December 31, 2018

CASE G: (Beginning of year collection) Bargain purchase option is P30,000.00

Date Collection Interest Principal PV
01/01/2017
01/01/2017
01/01/2018
01/01/2019
01/01/2020
1. Gross profit
2. Interest income for the year 2019
3. Carrying amount of lease receivable as of December 31, 2019
4. Journal entry when bargain purchase option is exercised
5. Journal entry when bargain purchase option is not exercised