Intermediate Accounting Part 2

Module 5
LEASES
Definition, Recognition,
Measurement and Presentation
(Points of View of Both the Lessee and the Lessor)

1
 Note 1
BASICS - Definition, Nature, Two Parties, Accounting Models

LEASES

IFRS 16

DEFINITION TWO PARTIES EXECUTORY COSTS LEASE MODEL - BASIC

IFRS 16, Appendix A
▪ A contract or part of a contract
▪ Conveys the right to use the LESSOR LESSEE FINANCE LEASE OPERATING LEASE
underlying asset MODEL (FLM) MODEL (OLM)
▪ for a period of time (base on provides the right to use
lease term) Like rent to own Simply renting an asset
a) Short-term (12 months or obtains the right to use
less from commencement By default, all leases shall Permitted to be used by
date) underlying / identified asset be accounted for using this the lessee under two
b) Long-term (beyond 12 lease model under IFRS 16 optional exemptions
months)
▪ in exchange for consideration Costs associated
Right to Control to having lease
Throughout the period of use, the Short-term lease (STL) Low value lease (LVL)
customer has the right over the Outright Expense 1) 12 months or less from 1) no threshhold
IFRS 16, Appendix B9 identified asset to: commencement date 2) a matter of professional
A contract must convey the right to obtain substantially all of the Maintenance 2) no lease option (like judgment
control the use of an identified economic benefits (exclusive Insurance purchase option) to
asset. use) Taxes transfer ownership at The lessee shall assess the
use directly (how and for what the end of the lease value of the underlying
purpose the asset should be term asset based on its value
used) 3) shall be made by class when it is new regardless of
of underlying asset. its age.

IFRS 16, Appendix B13 The lessee may still not apply OPERATING LEASE MODEL (OLM)
The asset is typically identified by: even if the lease is STL or LVL.
▪ explicitly specified in a contract
▪ implicitly specified when made
available to the customer

Option to extend the lease (if the lessee is reasonably

Noncancellable certain to exercise the extension option)
period to use the
underlyng asset
which includes: Option to terminate the lease (if the lessee is reasonably
certain not to exercise the termination of the lease)

2
Right of Use Asset - an asset, specifically PPE
Lease of payment - periodic, PV of Ordinary Annuity

Initial Measurement of PPE

Cost
Directly Attributable Cost
xx
xx
Note 2
Decommissioning Cost (cost to restore) xx ACCOUNTING – POINTOF VIEW OF THE LESSEE
xx
LEASES
Lease Liability
a) Lease Payment
ACCOUNTING FOR LESSEE
1) Variable
2) Fixed
b) Purchase Option -must be reasonably certain, with remaining life; tendency is no residual value FINANCE LEASE OPERATING LEASE
MODEL (FLM) MODEL (OLM)
guarantee
c) Lease Incentive - deducted to Lease Payment; directly attributable cost IFRS 16, Appendix A There is no transfer of risks and rewards
d) Lease Bonus - directly attributable cost A lease that transfers substantially all of to the lessee since the ownership of the
the risks and rewards incidental to underlying asset until the end of the lease
ownership of an underlying asset. term remain with the lessor.
If without Purchase Option:
1) With Residual Value Guarantee Initial Recognition Initial Recognition
2) No Residual Guarantee - not included in lease payment Recognizes the RIGHT OF USE ASSET Does not recognze the RIGHT OF USE
(RUA) account (a noncurrent asset ASSET (RUA) account , and the LEASE
account subject to depreciation), and the LIABILITY (LL) account. Instead, an
Number of periods - normally the lease term LEASE LIABILITY (LL) account (partly expense account is recognized for rental
Security Deposit - receivable current and noncurrent liability) on payment and accrual.
Incremental Borrowing Rate - the rate if u will make utang commencement date.
Right of Use Asset xxx Rent/Prepaid Exp. xxx
LeaseLiability xxx Cash xxx
Realty Taxes - not part of the computation of right of use asset; executory or outright expense
Lease Liability- the one amortized Allocation of rental if paid in
advance can either through:
Transfer of title - use the estimated useful life
Initial Measurement Subsequent Measurement 1) Straight-line method
▪ Take note of the
LL RUA IFRS 16, paragraph 29 escalation clause in the
PV of lease payments Use the COST MODEL 2) Another systematic basis if
▪ Fixed or Variable LP xxx more applicable than SLM
▪ Res. Value Guarantee xxx Important Consideration
▪ Bargain purchase option xxx RUA may be associated to: No problem with RUA
Cost Model
(reasonably certain) Subject to depreciation
▪ Penalties for terminating Property, plant and
the lease xxx equipment (IAS 16)
Initial Lease Liability xxx xxx Revaluation May elect to use in
Lease payments made to Model applying to all RUA
lessor at or before
commencement date: No problem with RUA
Cost Model
▪ Lease Bonus xxx Subject to depreciation
▪ Lease incentives / Investment Property
reimbursements (xxx) (IAS 40)
Initial direct costs incurred Fair Value RUA should be reported
by the lessee xxx Model at fair value
PV of Asset retirement Excluded from RUA
obligations such as: 1) Leasehold improvement -
▪ Dismantling costs xxx account separately as property, Subject to Depreciation IF any
▪ Removing costs xxx plant and equipment; subject to of the two conditions are met
▪ Restoration costs xxx depreciation over its useful life
Initial Right of Use Asset xxx or the lease term, whichever 1) There is transfer of ownership to the lessee at
is SHORTER. the end of the lease term.
2) Security deposit refundable 2) The lessee is reasonably certain to exercise
account separately as an asset. the bargain purchase option.
These lease payments are discounted
using the following (order of priority): IF MET, the depreciation should be based on any
1) Interest rate implicit in the lease of the following, whichever is SHORTER:
2) If number (1) is not available, use the 1) Useful life of the underlying asset (by default
incremental borrowing rate of the lessee. or if the problem is silent), or
Case 1: FV of underlying Asset 2) Lease term
< RV Guaranteed (RVG)
Loss on Finance Lease xxx
Cash xxx

3
 Note 3
ACCOUNTING – POINT OF VIEW OF THE LESSEE - DISCLOSURES

LEASES

ACCOUNTING FOR LESSEE

Minimum requirements of IFRS to
have a faithful representation of the DISCLOSURES IN THE FINANCIAL STATEMENTS
financial statements

Basic Disclosures Additional Disclosures

Depreciation charge for right of use assets by class of The nature of the lessee's leasing activities.
underlying asset. Future cash outflows to which the lessee is potentially
Interest expense on lease liability. exposed that are not reflected in the measurement of lease
The expense relating to short-term leases excluding the liability.
expense relating to leases with a term of one month or less. Variable lease payments
The expense relating to low value leases excluding the Extension option and termination option
expense relating to low value leases with term of one month Residual value guarantee
The expense relating to variable leses payments not included Leases not yet commenced to which the lessee is
in the measurement of lease liability. committed.
Income from subleasing right of use assets. Restrictions or covenants imposed.
Total cash outflow for leases.
Addition to right of use assets.
The carrying amount of right of use assets at the end of the
reporting period byclass of underlying asset
Short-term leases or low value leases accounted for as
operating lease.

4
 Note 4
TWO ACCOUNTING MODELS – POINT OF VIEW OF THE LESSOR
LEASES

ACCOUNTING FOR LESSOR

What accounting model to apply?

CRITERIA FOR FINANCE LEASE CRITERIA FOR OPERATING LEASE

Substance
There is transfer of ownership Over Form It does not meet any of the four criteria
Determinative in Nature (will conclude to FL)

of the underlying asset at the end that are determinative in nature to classify
of the lease term from the lessor to as finance lease.
the lessee.
It does not meet any of the four criteria
that are suggestive in nature to classify as
IFRS 16, paragraph 63

The lessee has the option to The lessee should be

purchase the asset (the expected reasonably certain to finance lease.
purchase price is significantly lower exercise the option to
than the FV at the exercise date) purchase. ACCOUNTING TREATMENT
FOR THE FOLLOWING TRA NSA CTIONS:
The lease term is for the major US GA AP FINA NCIA L STATEMENT PRESENTA TION
part of the ecoomic life of the Major part means 75% of Lease payments of the lessee Statement of Financial Position:
underlying asset even if title is not the economic life of the IFRS 16, paragraph 81 Asset:
transferred, asset. As income either on a straight-line basis or Property, Plant and Equipment:
another systematic basis. Underlying asset (specify) xxx
The PV of the lease payments US GA AP Cash/Rent Receivable xxx Accumulated Depreciation (xxx)
amounts to substantially all of Substantially all means Rent Income xxx Carrying amount xxx
the fair value of the underlying at least 90% of the fair Deferred Initial Direct Cost xxx
asset at inception date of the lease. value of the leased asset. Security deposit by the lessee Total carrying amount xxx
Cash xxx
Other Criteria (Suggestive Criteria) - May lead to FL Liability for Rent Deposit xxx Liability:
IFRS 16, paragraphs 63 and 64 Liability for Rent Deposit xxx
1) The underlying asset is of such specialized nature that only the Lease bonus from the lessee Unearned Rent Income xxx
lessee can use it without major modification. (To be amortized over the lease term)
2) If the lessee can cancel the lease, the lessor's losses associated Cash xxx
with the cancelation are borne by the lessee. Unearned Rent Income xxx Income Statement:
3) Gains or losses from the fluctuation in the fair value of the Rent Income
residual accrue to the lessee. Unearned Rent Income xxx From lease payment xxx
4) The lessee has the ability to continue the lease for a secondary Rent income xxx From lease bonus amort. xxx xxx
period at a rent that us substantially lower than market rent.
Initial direct cost paid Less: Operating Expenses:
CLASSIFICATION OF (To be amortized over the lease term) Executory costs (specify) xxx
FINA NCE LEASE Deferred Initial Direct Cost xxx Amortization of Initial DC xxx
Cash xxx Depreciation xxx xxx
1) Direct Finance Lease
2) Sales Type Lease Amortization of Initial DC xxx Net Income xxx
Deferred Initial DC xxx

Executory costs incurred

Operating Expense xxx
Cash xxx

Depreciation of Underlying Asset

Depreciation Expense xxx
Accumulated Dep. xxx

5
 Note 5
POINT OF VIEW OF THE LESSOR – THE CASE OF LAND BUILDING LEASE

LEASES

ACCOUNTING FOR LESSOR

LAND AND BUILDING LEASE

CONSIDER SEPARATELY IF CANNOT BE ALLOCATED

IFRS 16, Application Guide B55
The lease payments are allocated 1) The entire lease is classified as a finance lease, unless it is
in proportion to the relative clear that both elements are operatng leases.
fair value of the land and the 2) If the amount of the land element is immaterial, treat the land
building at the inception of the and the building as single unit and classified as a finance lease
lease. or an operating lease applying the lease classification criteria
for lessor. The economic life of the building is regarded as the
economic life of the entire underlying asset.

6
 PROBLEMS – ACCOUNTING FOR LESSEE
PROBLEM 1 (With fixed Lease Payment Payable at Reporting Date; there is transfer of ownership)
On January 1, 2025, Mark Company leased a machinery with estimated useful life of 3 years. The lease term is also for
3 years with annual rental at fixed amount of P 50,000 payable every December 31. At the end of the lease term, it is
provided in the lease that there is transfer of ownership from the lessor to the lessee. The applicable implicit interest rate
is determined to be 10%.

Required:
1. What is the present value of the right of use and lease liability at commencement date? Use four decimal places for
the present value factor. Round off your final answer to the nearest peso.
2. Prepare the table of amortization.
3. Compute the annual depreciation of Right of Use Asset.
4. Prepare the necessary journal entries for 2025.
5. Statement of Financial Position presentation as of December 31, 2025, 2026, and 2027 of Right of Use Asset and
Lease Liability.

ANSWERS:
1. What is the present value of the right of use and lease liability at commencement date?
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
1) Present value of:
Lease payment (less lease incentives, if any)
Computation: P 50,000 x 2.4869 124,345
b) Residual Value Guaranteed 0
c) Bargain purchase option (reasonably certain) 0
d) Penalties for terminating the lease 0
Initial Measurement of Lease liability 124,345 124,345
Any lease payments made on or before the commencement
date (less any lease incentives, if any) 0
Any initial direct cost incurred by the lessee 0
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset 0
2) Removing cost of the underlying asset 0
3) Restoration cost of the underlying asset 0
Initial measurement of Right-of-Use Asset 124,345

2. Prepare the table of amortization.

Solution:
Periodic Allocated Fixed Payment
Payment Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
FLP CA x 10% FLP – EIE PV + IE - FLP
0 01/01/2025 124,345
1 12/31/2025 50,000 12,435 37,565 86,780
2 12/31/2026 50,000 8,678 41,322 45,458
3 12/31/2027 50,000 4,542 45,458 0

3. Compute the annual depreciation of Right of Use Asset.

Solution:
Annual depreciation = Right-of-Use Asset Cost / Estimated Useful life
Annual depreciation = P 124,345 / 3 years
Annual depreciation = P 41,448
7
 Notes:
Right of Use Asset is subject to depreciation based on useful life of the asset or lease term, whichever is shorter.
The lease term and the estimated useful life of the right of use asset are the same which is 3 years.

4. Prepare the necessary journal entries for 2025.

Solution:
Date Transactions Account Names Debit Credit
2025
Jan. 1 Recognition of Right of Use Asset Right of Use Asset 124,345
and Lease Liability. Lease Liability 124,345

Dec. 31 Payment of annual fixed lease Interest Expense 12,435

payment (Refer to Table of Lease Liability 37,565
Amortization) Cash 50,000

Dec. 31 Annual depreciation for right of Depreciation Expense 41,448

use asset. Accumulated Depreciation 41,448

Date Transactions Account Names Debit Credit

2026
Dec. 31 Payment of annual fixed lease Interest Expense 8,678
payment (Refer to Table of Lease Liability 41,322
Amortization) Cash 50,000

Dec. 31 Annual depreciation for right of Depreciation Expense 41,448

use asset. Accumulated Depreciation 41,448

Date Transactions Account Names Debit Credit

2027
Dec. 31 Payment of annual fixed lease Interest Expense 4,542
payment (Refer to Table of Lease Liability 45,458
Amortization) Cash 50.000

Dec. 31 Annual depreciation for right of Depreciation Expense 41,449

use asset. Accumulated Depreciation 41,449

5. Statement of Financial Position presentation as of December 31, 2025, 2026, and 2027 of Right of Use Asset and
Lease Liability.
Answer:
01/01/2025 12/31/2025 12/31/2026 12/31/2027

Noncurrent Asset:
Right of Use Asset 124,345 124,345 124,345 124,345
Less: Accumulated Depreciation 0 41,448 82,896 124,345
Carrying Amount 124,345 82,897 41,449 0

Current Liability:
Lease Liability 37,565 41,322 45,458 0

Noncurrent Liability:
Lease Liability 86,780 45,458 0 0

8
PROBLEM 2 (With fixed Lease Payment Payable in Advance; No transfer of ownership) – AICPA Adapted
(Problem 10-1 from Intermediate Accounting Vol. 1, 2022 Edition by Valix, Peralta, Valix)
On January 1, 2025, Mixx Company entered into a lease for a new warehouse. Lease payments are P 800,000 a year for
5 years, payable in advance starting January 1, 2025. The warehouse had an estimated useful life of 10 years. The entity
paid initial direct cost of P 100,000 on January 1, 2025. The realty taxes of P 40,000 a year are paid by the entity. The
lease provided for neither transfer of title to the lessee upon expiration of the lease term nor a purchase option. The
underlying asset shall revert to the lessor at the expiration of the lease term. The interest rate implicit in the lease is 10%
The relevant present value factors are:
PV of an ordinary annuity of 1 at 10% for 5 periods 3.79
PV of an ordinary annuity of 1 in advance at 10% for 5 periods 4.17

Required (modified):
1. What is the present value of the right of use and lease liability at commencement date? Round off your final
answer to the nearest peso.
2. Prepare the table of amortization.
3. Compute the annual depreciation of Right of Use Asset.
4. Prepare the necessary journal entries for 2025 and 2026.
5. Statement of Financial Position presentation as of December 31, 2025, 2026, 2027, 2028 and 2029 of Right of Use
Asset and Lease Liability.

ANSWERS:
1. What is the present value of the right of use and lease liability at commencement date? Use four decimal places for
the present value factor. Round off your final answer to the nearest peso.
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: 3,336,000
b) Residual Value Guaranteed
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 3,336,000 3,336,000
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee 100,000
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 3,436,000

2. Prepare the table of amortization.

Solution:
Periodic Allocated Fixed Payment
Payment Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
FLP EIE = CA x 10% FLP – EIE PV + IE - FLP
0 3,336,000
1 800,000 2,536,000
2 800,000 253,600 546,400 1,989,600
3 800,000 198,960 601,040 1,388,560
4 800,000 138,856 661,144 727,416
5 800,000 72,584 727,416 0

9
3. Compute the annual depreciation of Right of Use Asset.
Solution:
Annual depreciation = Right-of-Use Asset Cost / years
Annual depreciation = 3,436,000 / 5 years
Annual depreciation = 687,200

Notes:

4. Prepare the necessary journal entries for 2025 and 2026.

Solution:
Date Transactions Account Names Debit Credit
2025
Jan. 1 Recognition of Right of ROUA 3,436,000
Use Asset and Lease Lease Liability 3,436,000
Liability.
Jan. 1 Payment of initial direct Lease
·ROUA Liability 100,000
cost. Cash – Initial Direct Cost 100,000

Jan. 1 Advance payment of Lease Liability 800,000

annual fixed lease Cash 800,000
payment for year 1.
Dec. 31 Accrual of interest Interest Expense 253,600
payable. Lease Liability 546,400
Cash 800,000

Dec. 31 Annual depreciation of Depreciation Expense 687,200

right of use. Accumulated Depreciation 687,200

Dec. 31 Annual payment of Tax Expense 40,000

realty taxes Cash 40,000

Date Transactions Account Names Debit Credit

2026
Jan. 1 Advance payment of Lease Liability 800,000
annual fixed lease Cash 800,000
payment for year 2.

Dec. 31 Accrual of interest Interest Expense 253,600

payable Lease Liability 546,400
Cash 800,000
Dec. 31 Annual depreciation of Depreciation Expense 687,200
right of use. Accumulated Depreciation 687,200

Dec. 31 Annual payment of Tax Expense 40,000

realty taxes Cash 40,000

10
5. Statement of Financial Position presentation as of December 31, 2025, 2026, 2027, 2028 and 2029 of Right of Use
Asset and Lease Liability.
Solution:
12/31/2025 12/31/2026 12/31/2027 12/31/2028 12/31/2029

Noncurrent Asset:
Right of Use Asset 3,436,000 3,436,000 3,436,000 3,436,000 3,436,000
Less: Acc. Dep. (687,200) (1,374,400) (2,061,600) (2,748,800) (3,436,000)
Carrying Amount 2,748,800 2,061,600 1,374,400 687,200 0

Current Liability:
Lease Liability 546,400 601,040 661,144 727,416 0

Noncurrent Liability:
Lease Liability 1,989,600 1,388,560 727,416 0 0

PROBLEM 3 (Fixed lease payment at reporting rate; with lease incentive; there is ownership transfer)
(Adapted from Problem 10-1 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Overland Company closed a lease contract for newly constructed terminals and freight storage
facilities. Although the terminals have a composite life of 10 years, the lease runs for 5 years with a transfer of title to
the lessee upon expiration of the lease. The annual lease payment is P 1,000,000 payable at the end of each year starting
December 31, 2024. The lessee must also make an annual payment of P 75,000 for taxes and P 125,000 for insurance.
The lessee incurred initial direct cost of P 150,000 including P 50,000 commission paid to the broker that arranged the
lease. As an incentive to the lessee, the lessor agreed to reimburse the lessee for the commission of P 50,000. The
contract was negotiated to assure the lessor a 10% rate of return. The present value of an ordinary annuity of 1 at 10%
for five periods is 3.79.

Required (modified):
1. What is the present value of the right of use and lease liability at commencement date?
2. Prepare the table of amortization.
3. Compute the annual depreciation of Right of Use Asset.
4. Prepare the necessary journal entries for 2024.

ANSWERS:
1. What is the present value of the right of use and lease liability at commencement date? Use four decimal places for
the present value factor. Round off your final answer to the nearest peso.
Solution:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: (1m x 3.79) 3,790,000
b) Residual Value Guaranteed
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 3,790,000
3,790,000 3,790,000
Any lease payments made on or before the commencement
date less any lease incentives (50,000)
Any initial direct cost incurred by the lessee 150,000
Asset retirement obligations at present value: 3,790,000
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 3,890,000

3,790,000 11
2. Prepare the table of amortization.
Solution:
Periodic Allocated Fixed Payment
Year Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
FLP EIE = CA x 10% FLP – EIE PV + IE - FLP
0 3,790,000
1 1,000,000 379,000 621,000 3,169,000
2 1,000,000 316,900 683,100 2,485,900
3 1,000,000 248,500 751,400 1,734,490
4 1,000,000 173,449 826,551 907,939
5 1,000,000 92,061 907,939 0

3. Compute the annual depreciation of Right of Use Asset.

Solution:
Annual depreciation = Right-of-Use Asset Cost / years
Annual depreciation = 3,890,000 / 10 years
Annual depreciation = 389,000

Notes:

4. Prepare the necessary journal entries for 2024.

Solution:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of Use ROUA 3,890,000
Asset and Lease Liability. Lease Liability 3,890,000

Jan. 1 Payment of initial direct =>

ROUA
Lease Liability 150,000
cost. Cash – Initial Direct Cost 150,000

Jan. 1 Reimbursement of ROUA 50,000

commission. Lease Liability 50,000

Dec. 31 Payment of annual fixed Lease Liability 1,000,000

lease payment year 1. Cash 1,000,000

Dec. 31 Annual Depreciation Depreciation Expense 389,000

Accumulated Depreciation 389,000

Dec. 31 Annual payment for taxes Tax Expense 75,000

and insurance Insurance Expense 125,000
Cash 200,000

12
PROBLEM 4 (With fixed lease payment; purchase Option is virtually certain) – AICPA Adapted
(Adapted from Problem 10-2 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Robbin Company leased a machine with the following provisions:

Annual lease payments in advance at the beginning of

each year, starting January 1, 2024 1,000,000
Lease term 10 years
Useful life of machine 14 years
Implicit interest rate in the lease 12%
PV of an ordinary annuity of 1 at 12% for 10 periods 5.650
PV of an annuity of 1 in advance at 12% for 10 periods 6.328
PV of 1 at 12% for 10 periods 0.322

The entity had an option to purchase the machine on January 1, 2034 by paying P 1,000,000. At the commencement
date, it is reasonably certain that the purchase option shall be exercised.

Required (modified):
1. What is the present value of the right of use and lease liability at commencement date?
2. Compute the annual depreciation of Right of Use Asset.
3. Prepare the table of amortization.
4. Prepare journal entries on the books of Robbin Company for 2024 and 2025.

ANSWERS:
1. What is the present value of the right of use and lease liability at commencement date?
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: (1m x 6.328) 6,328,000
a) Residual value guaranteed
b) Bargain purchase option
Computation: (1m x .322 PV of 1 since OTP) 322,000
c) Penalties for terminating the lease 3,790,000
Initial Measurement of Lease liability 6,650,000 6,650,000
Any lease payments made on or before the commencement
date less any lease incentives 3,790,000
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value: 3,790,000 3,790,000
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 6,650,000

2. Compute the annual depreciation of Right of Use Asset. NOTE!!!

Solution: 3,790,000
If with purchase option that is virtually certain or transfer of
Annual depreciation = Right-of-Use Asset Cost / years ownership, use the useful life in annual depreciation. If none,
Annual depreciation = 6,650,000 / 14 years whichever is shorter
Annual depreciation = 475,000

Notes:

13
3. Prepare the table of amortization.
Solution:
Periodic Allocated Fixed Payment
Year Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
FLP EIE = CA x 12% FLP – EIE PV + IE - FLP
0 6,650,000
1 1,000,000 1,000,000 5,650,000
2 1,000,000 678,000 322,000 5,328,000
3 1,000,000 639,360 360,640 4,967,360
4 1,000,000 596,083 403,917 4,563,443
5 1,000,000 547,613 452,387 4,111,056
6 1,000,000 493,327 506,673 3,604,383
7 1,000,000 432,526 567,474 3,790,000
3,036,909
8 1,000,000 364,429 635,571 2,401,338
9 1,000,000 3,790,000
288,161 711,839 1,689,499
10 1,000,000 310,501 689,499 1,000,000 1 Million Purchase Option
3,790,000
Notes:
3,790,000

3,790,000
4. Prepare journal entries on the books of Robbin Company for 2024 and 2025.
Solution:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of ROUA 6,650,000
Use Asset and Lease Lease Liability 6,650,000
Liability.
Jan. 1 Advance payment of fixed Lease Liability 1,000,000
lease payment for year Cash 1,000,000
2024.
Dec. 31 Annual Depreciation. Depreciation Expense 475,000
Accumulated Depreciation 475,000

Dec. 31 Accrual of interest Accrued Interest 678,000

expense. Interest Payable 678,000

Date Transactions Account Names Debit Credit

2025
Jan. 1 Advance payment of Lease Liability 1,000,000
fixed lease payment for Cash 1,000,000
year 2025.

Dec. 31 Annual Depreciation Depreciation Expense 475,000

Accumulated Depreciation 475,000

Dec. 31 Accrual of interest Accrued Interest 639,360

expense. Interest Payable 639,360

14
PROBLEM 5 (With fixed lease payment; with leasehold improvement & restoration cost) – AICPA Adapted
(Problem 10-4 from Intermediate Accounting Vol. 1, 2022 Edition by Valix, Peralta, Valix)
On January 1, 2024, Veronica Company negotiated a 15-year lease for a building with useful life of 20 years. The lease
provided for neither a transfer of title nor a purchase option. Before occupancy, the lessee incurred leasehold
improvement of P 600,000 with useful life of 5 years. The lessee is required to restore the building upon expiration of the
lease. The present value of estimated cost of restoration is P 644,000 discounted at 7%. Annual payments of P 1,000,000
are payable to the lessor on December 31 of each of the 15 years of the lease term. The lease was negotiated to assure
the lessor a 10% rate of return.

PV of an ordinary annuity of 1 at 10% for 15 periods 7.606

PV of an annuity of 1 in advance at 10% for 15 periods 8.367

Required (modified):
1. What is the present value of the right of use and lease liability at commencement date?
2. Prepare the table of amortization up to December 31, 2025.
3. Compute the annual depreciation of Right of Use Asset.
4. Prepare journal entries on the books of Veronica Company for 2024.

ANSWERS:
1. What is the present value of the right of use and lease liability at commencement date?
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
Preset value of:
a) Lease payment (less lease incentives, if any)
Computation: 7,606,000
a) Residual value guaranteed
b) Bargain purchase option
c) Penalties for terminating the lease
Initial Measurement of Lease liability 3,790,000
7,606,000 7,606,000
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value: 3,790,000 3,790,000
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset 644,000
Initial measurement of Right-of-Use Asset 8,250,000

2. Prepare the table of amortization.

Solution: 3,790,000
Periodic Allocated Fixed Payment
Year Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
EIE = CA x 10% FLP – EIE PV + IE - FLP
0 01/01/2024 7,606,000
1 12/31/2024 1,000,000 760,600 239,400 7,366,600
2 12/31/2025 1,000,000 736,660 263,340 7,103,260

3. Compute the annual depreciation of Right of Use Asset.

Solution: 3,790,000
3,790,000 Asset3,790,000
Annual depreciation = Right-of-Use Cost / years 3,790,000
Annual depreciation = 8,250,000 / 15 years
Annual depreciation = 550,000

15
 Notes:

4. Prepare journal entries on the books of Veronica Company for 2024.

Solution:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of ROUA 7,606,,000
Use Asset and Lease Lease Liability 7,606,,000
Liability.
Jan. 1 Recognition of ROUA 644,000
estimated restoration Decommissioning Liability 644,000
cost at present value.
Jan. 1 Cost of leasehold Leasehold Improvement 600,000
improvements Cash 600,000

Dec. 31 Depreciation of Right of Depreciation Expense 550,000

Use during the year. Accumulated Depreciation 550,000

Dec. 31 Depreciation of Depreciation Expense – L.I 120,000

leasehold improvement Accumulated Depreciation – L.I 120,000
during the year. (600,000/5 years)
Dec. 31 Payment of annual fixed Lease Liability 760,600
lease payment for year Interest Expense 239,400
2024 Cash 1,000,000

Dec. 31 Amortization of Interest Expense 45,080

estimated restoration Decommissioning Liability 45,080
cost (644,000 x 7%)

PROBLEM 6 (With guaranteed residual value; asset to revert to lessor)

(Problem 10-5 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Lessee Company entered into a lease with Lessor Company for a new equipment. The lessee
stipulated that annual payments of P 1,000,000 shall be made for five years starting December 31, 2024. Lessee Company
guaranteed a residual value of P 474,060 at the end of the 5-year period. The equipment shall revert to the lessor at the
lease expiration. The implicit interest rate for the lease is 16% after considering the guaranteed residual value. The
economic life of the equipment is 10 years. The present value factors at 16% for five periods are: Present value of 1 –
0.4761; Present value of an ordinary annuity of 1 – 3.2743.

Required (modified):
1. Compute the present value of the right of use and lease liability at commencement date.
2. Prepare a schedule of the annual payments showing reduction of liability every year.
3. Compute the annual depreciation of Right-of-Use Asset.
4. Prepare journal entries on the books of the Lessee Company for 2024 and 2025.
5. Prepare journal entry on December 31, 2028, end of lease term, to record the return of the equipment to the lessor.
Assume the fair value of the equipment is equal to the guaranteed residual value.
6. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor assuming the fair
value of the equipment is only P 300,000.
7. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor assuming the fair
value of the equipment is only P 500,000.
16
ANSWERS:
1. Compute the present value of the right of use and lease liability at commencement date.
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: (1m x 3.2743) 3,274,300
a) Residual value guaranteed
Computation: (474,060 x .4761) 225,700
b) Bargain purchase option
c) Penalties for terminating the lease
Initial Measurement of Lease liability 3,500,000 3,500,000
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 3,500,000

2. Prepare a schedule of the annual payments showing reduction of liability every year.
Solution:
Periodic Allocated Fixed Payment
Fixed Lease Effective Lease Liability PV or CA of
Year No. Date Payment Interest Exp. Amortization Lease Liability
EIE = CA x 16% FLP – EIE PV + IE - FLP
0 3,500,000
1 1,000,000 560,000 440,000 3,060,000
2 1,000,000 489,600 519,400 2,549,600
3 1,000,000 407,936 592,064 1,957,536
4 1,000,000 313,206 686,794 1,270,742
5 1,000,000 203,318 796,682 474,060

Notes:

3. Compute the annual depreciation of Right-of-Use Asset.

Solution:
Annual depreciation = (ROU Asset Cost – Guaranteed Residual Value) / years
Annual depreciation = (3,500,000 - 474,060) / 5
Annual depreciation = 3,025,940 / 5
Annual depreciation = 605,188

Notes:
 The guaranteed residual cost is deducted from cost of right of use to compute the depreciation
because this would be paid to the lessor at the end of the lease term in case the actual residual
value is lower than what is estimated at commencement date of the lease contract.

17
4. Prepare journal entries on the books of the Lessee Company for 2024 and 2025.
Solution:

Date Transactions Account Names Debit Credit

2024
Jan. 1 Recognition of Right of Use ROUA 3,500,000
Asset and Lease Liability. LL 3,500,000

Dec. 31 Payment of fixed lease Interest Exp. 560,000

payment for 2024. Lease Liability 440,000
Cash 1,000,000

Dec. 31 Annual depreciation of Dep. Exp 605,188

right of use Acc. Dep 605,188

Date Transactions Account Names Debit Credit

2025
Dec. 31 Payment of fixed lease Interest Exp. 489,600
payment for 2025. Lease Liability 519,400
Cash 1,000,000

Dec. 31 Annual depreciation of Dep. Exp 605,188

right of use Acc. Dep 605,188

5. Prepare journal entry on December 31, 2028, end of lease term, to record the return of the equipment to the
lessor. Assume the fair value of the equipment is equal to the guaranteed residual value.
Solution:
Date Transactions Account Names Debit Credit
2028
Dec. 31 Return of the equipment to Acc Dep 3,025,940
the lessor. Lease Liability 474,060
ROUA 3,500,000

6. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor assuming the fair
value of the equipment is only P 300,000.
Solution:
Date Transactions Account Names Debit Credit
2028
Dec. 31 Return of the equipment to Acc Dep 3,025,940
the lessor. Lease Liability 474,060
ROUA 3,500,000

Dec. 31 Payment of cash to Loss on Finance Lease 174,060

recognize loss on finance Cash (474,060 - 300,000) 174,060
lease.

18
 Notes:

7. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor assuming the fair
value of the equipment is only P 500,000.
Solution:
Date Transactions Account Names Debit Credit
2028
Dec. 31 Return of the equipment to Acc Dep 3,025,940
the lessor. Lease Liability 474,060
ROUA 3,500,000

Notes:

PROBLEM 7 (With unguaranteed residual value; No transfer of title at the end of lease term) - IFRS
(Problem 10-7 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
Dexter Company had maintained a policy of acquiring equipment by leasing. On January 1, 2024, Dexter Company
entered into a lease agreement for an equipment with useful life of 8 years.

The lease stipulated an annual rental payment of P 600,000 to be paid every December 31 starting December 31, 2024.
The lease contains neither a transfer of title to the lessee nor a purchase option.

The equipment had a residual value of P 300,000 at the end of the 5-year lease term but is unguaranteed by the lessee.

The implicit interest rate is 12% after considering the unguaranteed residual value. The present value of an ordinary
annuity of 1 at 12% for 5 periods is 3.60.

Required (modified):
1. Compute the present value of the right of use and lease liability at commencement date.
2. Prepare a schedule of the annual payments showing reduction of liability every year.
3. Compute the annual depreciation of Right-of-Use Asset.
4. Prepare journal entries on the books of Dexter Company for 2024.
5. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor as required by the
contract. The fair value of the equipment is P 200,000.

19
ANSWERS:
1. Compute the present value of the right of use and lease liability at commencement date.
Solution:
Lease Right-of-
Liability Use Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: (600,000 x 3.60) 2,160,000
b) Guaranteed residual value
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 2,160,000 2,160,000
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 2,160,000

Notes:

2. Prepare a schedule of the annual payments showing reduction of liability every year.
Solution:
Periodic Allocated Fixed Payment
Year Fixed Lease Effective Lease Liability PV or CA of
No. Date Payment Interest Exp. Amortization Lease Liability
EIE = CA x 12% FLP – EIE PV + IE - FLP
0 2,160,000
1 600,000 259,200 340,800 1,819,200
2 600,000 218,304 381,696 1,437,504
3 600,000 172,500 427,500 1,010,004
4 600,000 121,200 478,800 531,204
5 600,000 68,796 531,204 0

3. Compute the annual depreciation of Right-of-Use Asset.

Solution:
Annual depreciation = ROU Asset Cost / years
Annual depreciation = 2,160,000/5
Annual depreciation = 432,000

Notes:
 The unguaranteed residual value is ignored in the computation of depreciation. In effect, at the
end of the useful life of right of use asset, the carrying amount is zero. This is the burden of the
lessor and not the lessee,

20
4. Prepare journal entries on the books of Dexter Company for 2024.
Solution:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of Use Right of Use of Asset 2,160,000
Asset and Lease Liability. Lease Liability 2,160,000

Dec. 31 Payment of fixed lease Interest Expense 259,200

payment for 2024. Lease Liability 340,800
Cash 600,000

Dec. 31 Annual depreciation of Depreciation Expense 432,000

right of use Acc. Depreciation 432,000

5. Prepare journal entry on December 31, 2028 to record the return of the equipment to the lessor as required by the
contract. The fair value of the equipment is P 200,000.
Solution:
Date Transactions Account Names Debit Credit
2028
Dec. 31 Return of the equipment to Acc Dep (432,000 x 5) 2,160,000
the lessor. ROUA 2,160,000

Notes:

PROBLEM 8 (With purchase option is reasonably certain) - IFRS

(Problem 10-25 from Intermediate Accounting Vol. 1, 2022 Edition by Valix, Peralta, Valix)
At the beginning of the current year, Panorama Company leased a building from a lessor with the following pertinent
information:

Annual rental payable at the end of each year 1,000,000

Initial direct cost paid 400,000
Lease incentive received 100,000
Leasehold improvement 200,000 (do not include)
Purchase option that is reasonably certain to be exercised 500,000
Lease term 5 years
Useful life of building 8 years
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
Present value of 1 for 5 periods at 10% 0.62

QUESTIONS:
1. What amount should be recognized initially as cost of the right of use asset?
A. P 4,500,000
B. P 4,400,000
C. P 4,700,000
D. P 4,600,000

21
 SOLUTION:
Lease Liability RU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: 3,790,000
b) Guaranteed residual value
c) Bargain purchase option
Computation: 310,000
d) Penalties for terminating the lease
Initial Measurement of Lease liability 4,100,000 4,100,000
Any lease payments made on or before the commencement
date less any lease incentives (100,000)
Any initial direct cost incurred by the lessee 400,000
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 4,400,000

2. What amount should be recognized as depreciation of right of use asset for current year?
A. P 880,000
B. P 900,000
C. P 550,000
D. P 575,000

SOLUTION:
Annual depreciation = ROU Asset Cost / years
Annual depreciation = 4,400,000 / 8 years
Annual depreciation = 550,000
Notes:
 The unguaranteed residual value is ignored in the computation of depreciation. In effect, at the end of
the useful life of right of use asset, the carrying amount is zero.

3. What amount should be recognized as interest expense for the current year?
A. P 410,000
B. P 379,000
C. P 450,000
D. P 429,000
SOLUTION:
Interest expense for the current year = PV of lease payment and purchase option price x implicit interest rate
Interest expense for the current year = 4,100,000 x 10%
Interest expense for the current year = 410,000

4. What amount should be reported as lease liability at year-end?

A. P 3,510,000
B. P 3,169,000
C. P 3,950,000
D. P 3,719,000

SOLUTION:
Lease liability January 1, 2022 4,100,000
Less: Applicable payment to lease liability
Annual lease payment 1,000,000
Less: Applicable to interest expense 410,000 590,000
Lease liability, December 31, 2022 3,510,000

22
 PROBLEMS – ACCOUNTING FOR LESSEE
Remeasurement of Lease Liability

PROBLEM 9 (Reassessment of lease term – Increase in Lease Term)

With Subsequent decision to exercise the lease extention option; advance payment of lease payment
(Adapted from Illustration 1 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Chocolate Company signed a five-year lease contract covering an office space with annual lease
payment of P 900,000 which is due every January 1 of each year. On this date, the incremental borrowing rate is 7% In
addition, the lease contract gives Chocolate Company the option to extend the lease term for additional 3 years. As of
commencement date, it is not reasonably certain that it will exercise extension option. After one year, on January 1,
2024, Chocolate Company decided to exercise the extension option. On this date, the incremental borrowing rate is 9%.

Requirement:
Use six decimal places for present value factors. Round off your final answer to the nearest peso.
1. Determine the initial measurement of lease liability and ROU Asset as of January 1, 2023.
2. Determine the annual depreciation during the five-year lease term.
3. Prepare the table of amortization for the five-year lease term.
4. Prepare the journal entries for the years 2023.
5. Present the Right-of-Use Asset and Lease Liability in the Statement of Financial Position as of December 31, 2023
and 2024.
6. Determine the increase in lease liability on January 1, 2024 as a result of exercise of extension option by Chocolate
Company.
7. Determine the revised annual depreciation after the lease extension on January 1, 2024.
8. Prepare the revised table of amortization for the years 2024 to 2030.

SOLUTIONS:
1. Determine the initial measurement of lease liability and ROU Asset as of January 1, 2023.
Answer:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Lease payment (less lease incentives, if any)
Computation: (900k x 4.387211) 3,948,490
b) Guaranteed residual value
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 3,948,490 3,948,490
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 3,948,490

2. Determine the annual depreciation during the original five-year lease term.
Answer:
Initial cost of Right-of-Use Asset 3,948,490
Less: Residual Value
Depreciable cost of Right-of-Use Asset
Divide by lease term in years (no useful life is given) 5
Annual depreciation 789,698

23
3. Prepare the table of amortization for the five-year lease term.
Answer:
Annual Lease Interest Lease Liability
Payment Date Payment Expense Amortization Carrying Amt.
(CA x 7%) (CA-ALP+IE)
Cash – Cr. Int. Exp – Dr. L. Liability – Dr.
0 3,948,490
1 900,000 3,048,490
2 900,000 213,394 686,606 2,361,884 (ca of LL 2024 before remeasurement)
3 900,000 165,332 734,668 1,627,216
4 900,000 113,905 786,095 841,121
5 900,000 58,879 841,121 0

Notes: Take note that all amortization amounts of lease liability are aligned to date of advance payment of lease which is
January 1 of every year but the actual amortization will be recorded in accounting books every end of the accounting period.
To avoid confusion in using the table in the presentation of Lease Liability in the statement of financial position, this may
be revised as follows:

4. Prepare the journal entries for the years 2023.

Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of Right of Use Right-of-Use
ROUA Asset 3,948,490
3,948,490
Asset and Lease Liability. Lease Liability
LL 3,948,490
3,948,490

Jan. 1 First advance payment of LL Liability

Lease 900,000
900,000
annual lease for the year Cash
Cash 900,000
900,000
2023.
Dec. 31 Interest accretion for 2023 Interest Expense
Interest Expense 213,394
213,394
Interest Payable
Interest Payable 213,394
213,394

Dec. 31 Annual depreciation for Depreciation Expense

Depreciation Expense 789,698
789,698
2023 Accumulated Depreciation
Accumulated Depreciation 789,698
789,698

5. Present the Right-of-Use Asset and Lease Liability in the Statement of Financial Position as of December 31, 2023.
Answer:
Noncurrent Asset:
Right-of-Use Asset 3,948,490
3,948,490
Less: Accumulated Depreciation 789,698
(789,698)
Carrying Amount 3,158,792
3,158,792

Current Liability:
Lease Liability 686,606
686,606

Noncurrent Liability:
Lease Liability 2,361,884
2,361,884

24
6. Determine the increase in lease liability on January 1, 2024 due to exercise of extension option by Chocolate
Company.
Answer:
Annual lease payment for remaining six years 900,000
900,000 Lease Liability
Multiply by PV of ordinary annuity of 1 for 6 years at 9% 4.485919
4.485919 2,361,884
2,361,884 Unadjusted
Adjusted Present Value of lease payments for six years 4,037,327
4,037,327
Less: Unadjusted PV before lease term extension 1,675,445
1,675,443 AJE
(See original table of amortization, at 01/01/2024) 2,361,884
(2,361,884)
Increase in Lease Liability 1,675,443
1,675,443 4,037,327
4,037,327 Adjusted
Notes:
a) Six years is used because the last payment happened on January 1, 2024. Therefore, from the original lease
term of five years, two years were already expired. The remaining lease term is three years plus three years
extension term equals six years.
b) The PV of ordinary annuity is used because after January 1, 2024 (date of last payment), the next payment
would be after one year which is January 1, 2025. Therefore, it is no longer an advance payment of lease rental.

7. Prepare the journal entry to record the second advance payment of lease increase in liability on January 1, 2024 due
to exercise of extension option by Chocolate Company.
Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Second advance payment Lease LL Liability 686,606
686,606
of annual lease for the year Interest Payable
Interest Expense 213,394
213,394
2024. Cash
Cash 900,000
900,000

Ja1. 1 Increase in lease liability Right-of-Use

ROUA Asset 1,675,443
1,675,433
(remeasurement) due to Lease Liability
LL 1,675,443
1,675,433
exercise of extension
option
Notes: The increase in the Lease Liability account is the same increase in Right-of-Use Asset.

8. Determine the revised annual depreciation after the lease extension on January 1, 2024.
Answer:
Right-of-Use Asset before lease extension (reassessment)
(Refer to Statement of Financial Position, 12/31/2024) 3,158,792
3,158,792
Add: Increase in Lease Liability 1,675,443
1,675,433
Adjusted carrying amount of ROU Asset after reassessment 4,834,235
4,834,235
Divide remaining revised lease term in years 7 7
Revised annual depreciation of Right-of-Use Asset 690,605
690,605
Notes: The seven (7) years is for the years 2024, 2025, 2026, 2027, 2028, 2029, and 2030.

9. Prepare the revised table of amortization for the years 2024 to 2030.
Answer:
Annual Lease Interest Lease Liability
Payment Date Payment Expense Amortization Carrying Amt.
(CA x 9%) (CA-ALP+IE)
Cash – Cr. Int. Exp – Dr. L. Liability – Dr.
2 01/01/2024 4,037,327
3 01/01/2025
2025 900,000
900,000 363,359
363,359 536,641
536,641 3,500,686
3,500,686
4 01/01/2026
2026 900,000
900,000 315,062
315,062 584,934
584,938 2,915,748
2,915,748
5 01/01/2027
2027 900,000
900,000 262,417
262,417 637,583
637,583 2,278,165
2,278,165
6 01/01/2028
2028 900,000
900,000 205,035
205,035 694,965
694,965 1,583,200
1,583,200
7 2029
01/01/2029 900,000
900,000 142,488
142,488 757,512
757,512 825,688
825,688
8 2030
01/01/2030 900,000
900,000 74,312
74,312 825,688
825,688 0 0

25
PROBLEM 10 (Reassessment of lease term – Lease Term Extension from not certain to certain) - IFRS
Subsequent decision to exercise lease term extension option; lease payment every year-end
(Adapted from Problem 11-1 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Cavalier Company entered into a lease of building with the following information:

Annual rental payment at the end of each year 600,000

Lease term 5 years
Useful life of building 20 years
Implicit interest rate 9%
PV on an ordinary annuity of 1 at 9% for 5 period 3.89

The lease contained an option for the lessee to extend the lease for a further 5 years. At the commencement date, the
exercise of the extension option is not reasonably certain.

After 3 years on January 1, 2027, the lessee decided to extend the lease for a further 5 years.

New annual rental payable at the end of each year 800,000

New implicit interest rate 12%
PV of an ordinary annuity of 1 at 12% for 5 periods 3.605
PV of 1 at 12% for 2 periods 0.797
PV of an ordinary of 1 at 12% for 2 periods 1.690

Required (modified):
1. Determine the present value of Right-of-Use Asset as of January 1, 2024.
2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
3. Prepare a table of amortization for 2024, 2025, and 2026
4. Prepare the journal entries for 2024.
5. Determine the increase in lease liability on January 1, 2027 due to exercise of extension option.
6. Determine the revised annual depreciation after the lease extension and increase in lease payment on January 1,
2027.
7. Prepare a new table of amortization from 2027 to 2033.
8. Prepare journal entries for 2027.
9. Present the Right-of-Use Asset and Lease Liability in the Statement of Financial Position as of December 31, 2027,
2028 and 2029.

SOLUTION:
1. Determine the present value if Right-of-Use Asset as of January 1, 2024.
Answer:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Fixed lease payment less lease incentives, if any
Computation: 2,334,000
b) Guaranteed residual value
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 2,334,000 2,334,000
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 2,334,000

26
2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
Answer:
Present value at January 1, 2024 (See Letter A) 2,334,000
Divide by lease term (shorter than useful life) 5
Annual depreciation 466,800
Notes:
The problem is silent if the underlying asset will be transferred to the lessee at the end of the lease term. Therefore,
it is assumed that the there is no transfer of ownership title at the end of the lease term. In this case, the depreciation
of ROU Asset is whichever is shorter of its useful life (20 years) and lease term (5 years). The shorter is the lease
term of 5 years.

3. Table of amortization for 2024, 2025, and 2026.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Dates Payment (Accretion) Amortization Amount
1/1/2024 (CA x 9 %) 2,334,000
12/31/2024 600,000 210,060 389,940 1,944,060
12/31/2025 600,000 174,965 425,035 1,519,025
12/31/2026 600,000 136,712 463,288 1,055,737
12/31/2027 600,000 95,016 504,984 550,753
12/31/2028 600,000 49,247 550,753 0
4. Journal entries for 2024.
Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of Use Right
ROUAof Use Asset 2,334,000
2,334,000
Asset and Lease Liability. Lease Liability
LL 2,334,000
2,334,000

Dec. 31 Payment of fixed lease Interest Expense

Interest Expense 210,060
210,060
payment and interest Lease
LL Liability 389,940
389,940
accretion for 2024. Cash
Cash 600,000
600,000

Dec. 31 Annual depreciation of Depreciation

Dep. Exp Expense 466,800
466,800
right of use Accumulated
Acc. Dep Depreciation 466,800
466,800

5. Determine the increase in lease liability on January 1, 2027 due to exercise of extension option.
Answer:
Annual lease payment for remaining 2 years (original lease payment) 600,000
Multiply by PV of ordinary annuity of 1 for 2 years at 12% (new) 1.690
Adjusted Present Value of original lease payments for remaining 2 years 1,014,000
Add: PV of new lease payment for 5 years extension
New annual lease payment based on 5 years extension 800,000
Multiply by PV of ordinary annuity of 1 for 5 periods at 12% (new) 3.6048
PV of new lease payment for 5 years extension (from year 2029) 2,884,000
Multiply by PV of 1 for 2 periods at 12% (new) 0.797 2,298,548
Adjusted carrying amount of lease liability as of January 1, 2027 3,312,548
Less: Unadjusted carrying amount of lease liability as of January 1, 2027
(Refer to original table of amortization – Requirement 3 (1,055,737)
Increase in Lease Liability as of January 1, 2027 2,256,811

Notes:
Any increase (decrease) in Lease Liability is also the increase (decrease) in Right-of-Use Asset. The effect of the
remeasurement of Lease Liability is direct to Right-of-Use Asset.

27
6. Determine the revised annual depreciation after the lease extension and increase in lease payment on January 1,
2027.
Answer:
Right-of-Use Asset, January 1, 2024, commencement date 2,334,000
Less: Accumulated Depreciation from 2024 to 2026
Computation: (466,800 x 3) 1,400,400
Carrying amount of ROU Asset, January 1, 2027, before reassessment 933,600
Add: Increase in ROU Asset on January 1, 2027 during reassessment 2,256,811
Adjusted carrying amount of ROU Asset, January 1, 2027 3,190,411
Divide remaining revised lease term in years 7
Revised annual depreciation of Right-of-Use Asset from 2027 to 2033 455,773

Notes: The seven (7) years is for the years 2027 (current), 2028, 2029, 2030, 2031, 2032, and 2033
(prospective).

7. Prepare a new table of amortization from 2027 to 2033.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Dates Payment (Accretion) Amortization Amount Remarks
(CA-ALP+IE)
(CA x 12 %) (CA – LL Amort)
January 1, 2027 3,312,548 Remaining 2 years from
December 31, 2027 600,000 397,506 202,494 3,110,054 original lease term
December 31, 2028 600,000 373,206 226,794 2,883,260
December 31, 2029 800,000 345,991 454,009 2,429,251
December 31, 2030 800,000 291,510 508,490 1,920,761
800,000 Extension or additional
December 31, 2031 230,491 569,509 1,351,252
800,000 lease term of 5 years
December 31, 2032 162,150 637,850 713,402
December 31, 2033 800,000 86,598 713,402 0

8. Prepare journal entries for 2027.

Answer:
Date Transactions Account Names Debit Credit
2027
Jan. 1 Remeasurement of lease ROUA 2,256,811
liability LL 2,256,811

Dec. 31 Payment of fixed lease Interest Exp. 397,506

payment for 2027. LL 202,494
Cash 600,000

Dec. 31 Annual depreciation of Dep. Exp 455,773

right of use Acc Dep 455,77
(P 3,190,411 / 7 years) 3

28
9. Present the Right-of-Use Asset and Lease Liability in the Statement of Financial Position as of December 31, 2027,
2028 and 2029.
Answer:
12/31/2027 12/31/2028 12/31/2029
Noncurrent Asset:
Right-of-Use Asset 4,590,811
4,590,811 4,590,811
4,590,811 4,590,811
4,590,811
Less: Accumulated Depreciation 1,856,176
1,856,176 2,311,946 2,767,719
Carrying Amount 2,734,638 2,278,865 1,823,092

12/31/2025 12/31/2026 12/31/2027

Current Liability:
Lease Liability: 226,794 454,009 508,490

Noncurrent Liability:
Lease Liability 2,883,260 2,429,251 1,920,761

Supporting computation for Accumulated Depreciation of ROU Asset:

Computation Cost Acc. Dep.
Right-of-Use Asset, January 1, 2024, commencement date 2,334,000 2,334,000
Less: Accumulated Depreciation from 2024 to 2026
Computation: 1,400,400 1,400,400
Carrying amount of ROU Asset, January 1, 2027, before reassessment 933,600
Add: Increase in ROU Asset on January 1, 2027 during reassessment 2,256,811 2,256,811
Adjusted carrying amount of ROU Asset, January 1, 2027 3,190,411
Divide remaining revised lease term in years 7
Revised annual depreciation of Right-of-Use Asset from 2027 to 2033 455,773
Adjusted cost of Right-of-Use Asset 4,590,811
Depreciation expense for 2027 455,773
Accumulated Depreciation, 12/31/2027 1,856,173 1,856,173
Carrying Amount 12/31/2027 2,734,638
Depreciation expense for 2028 455,773
Accumulated Depreciation, 12/31/2028 2,311,946
Depreciation expense for 2028 455,773
Accumulated Depreciation, 12/31/2028 2,767,719

PROBLEM 11 (Reassessment of lease term – Lease Term extension from certain to not certain)
With Subsequent decision not to exercise lease term extension option; advance lease payment
(Adapted from Illustration 2 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Jakarta Company signed a seven-year lease contract involving a vehicle with annual lease payment
of P 600,000 due every January 1 starting on that date. Incremental borrowing rate is 8%. In addition, Jakarta Company
has the option to extend the lease term for an additional three years, which was reasonably expected to be exercised.
On January 1, 2025, the company reassessed that it will not exercise the extension since it decided to look instead for a
more updated version of the vehicle at the end of the lease term. Incremental borrowing rate in this date is 6%.

Required:
Use six decimal places for present value factors. Round off your final answer to the nearest peso.
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
3. Prepare a table of amortization.
4. Prepare the journal entries for 2023 and 2024.
5. Determine the carrying amount of the Right-of-Use Asset as of January 1, 2025, the date when option will not be
exercised.
6. Determine the decrease in lease liability on January 1, 2025.
7. Prepare the revised table of amortization on January 1, 2025.
8. Determine the revised annual depreciation of Right-of-Use Asset from year 2025.
9. Prepare the journal entries for the year 2025 and 2026.

29
SOLUTIONS:
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
Answer:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Fixed lease payment less lease incentives, if any
Computation: (600,000 x 5.622880) 3,373,728
b) Guaranteed residual value
c) Bargain purchase option
d) Penalties for terminating the lease
Initial Measurement of Lease liability 3,373,728 3,373,728
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset 3,373,728

2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
Answer:
Initial cost of Right-of-Use Asset 3,373,728
Less: Residual Value
Depreciable cost of Right-of-Use Asset
Divide by lease term in years (no useful life is given) 7
Annual depreciation 481,961

3. Prepare a table of amortization.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Dates Payment (Accretion) Amortization Amount
1/1/2023 (CA x 8 %) 3,373,728
1/1/2023 600,000 600,000 2,773,728
1/1/2024 600,000 221,898 378,102 2,395,626
1/1/2025 600,000 191,650 408,350 1,987,276 (Unadjusted LL Balance)

4. Prepare the journal entries for 2023 and 2024.

Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of Right of Use ROUA 3,373,728
Asset and Lease Liability. LL 3,373,728

Jan. 1 Advance payment of fixed LL 600,000

lease payment for 2023 Cash 600,000

Dec. 31 Interest accretion for 2023. Interest Expense 221,898

Interest Payable 221,898

30
 Dec. 31 Annual depreciation of Depreciation Expense 481,961
right of use asset Accumulated Depreciation 481,961

2024
Jan. 1 Advance payment of fixed LL 600,000
lease payment for 2024 Cash 600,000

Dec. 31 Interest accretion for 2024. Interest Expense 191,650

Interest Payable 191,650

Dec. 31 Annual depreciation of Depreciation Expense 481,961

right of use Accumulated Depreciation 481,961

5. Determine the carrying amount of the Right-of-Use Asset as of January 1, 2025, the date when option will not be
exercised.
Answer:
Initial cost of Right-of-Use Asset 3,373,728
Less: Accumulated Depreciation from 2023 to 2024
Computation: (963,922)
Carrying amount of ROU Asset, 1/1/2025 2,409,806

6. Determine the decrease in lease liability on January 1, 2025.

Answer:
Adjusted present Value of remaining lease payment
Computation: (600k x .943396 PV of 1 6%) 566,038
Unadjusted present value of lease liability, 1/1/2025
(refer to table of amortization under requirement 3) 1,987,276
Decrease in Lease Liability, 1/1/2025 (1,421,238)
Notes:
The seven years lease term included the extension of 3-years since from commencement date, Jakarta Company was
reasonably certain to exercise the extension option. Since on January 1, 2025 or two years after the lease commencement
date, Jakarta decided not to exercise the extension option, the adjusted original lease term is now four years (7 years - 3
years option). Out of this revised four years term, three lease payments were already made as follow: January 1, 2023;
January 1, 2024, and; January 1, 2025. Therefore, there is only one lease payment to be made during its revised lease
term which will happen on January 1, 2026 (end of lease term). Therefore, the PV of 1 for one period at 6% incremental
borrowing rate will be used, or the PVF of 0.943396.

7. Prepare the revised table of amortization on January 1, 2025.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Dates Payment (Accretion) Amortization Amount
(CA x 6 %)
January 1, 2025 566,038
January 1, 2026 600,000 33,962 566,038

8. Determine the revised annual depreciation of Right-of-Use Asset from year 2025.
Answer:
Carrying amount of ROU Asset, before reassessment 2,409,806
Less: Decrease in Right-of-Use Asset on 1/1/2025 (1,421,238)
Carrying amount of ROU Asset, after reassessment 988,568
Divide by remaining lease term in years 2
Revised annual depreciation from year 2025 494, 284
31
9. Prepare the journal entries for the year 2025 and 2026.
Answer:
Date Transactions Account Names Debit Credit
2025
Jan. 1 Advance payment of fixed Lease Liability 408,350
lease payment for 2025 Interest Payable 191,650
Cash 600,000

Jan. 1 Decrease in lease liability Lease Liability 1,421,238

as a result of Right-of-Use Asset 1,421,238
remeasurement.
Dec. 31 Interest accretion for 2023. Interest Expense 33,962
Interest Payable 33,962

Dec. 31 Annual depreciation of Depreciation Expense 494,284

right of use asset Accumulated Depreciation 494,284

2026
Jan. 1 Advance payment of fixed Lease Liability 566,038
lease payment for 2026 Interest payable 33,962
Cash 600,000

Dec. 31 Annual depreciation of Depreciation Expense 494,284

right of use asset Accumulated Depreciation 494,284

PROBLEM 12 (Reassessment of lease term – With Purchase Option from certain to uncertain)
Subsequent Decision Not to Exercise Purchase Option; advance lease payment
(Adapted from Illustration 3 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Viral Company entered into a 4-years lease contract with annual lease payment of P 1,000,000 which
is payable in advance. The estimated useful of the underlying asset is 6 years. The lease contract has a purchase option
price of P 700,000 in which Viral Company is reasonably certain to exercise such option. The residual of the underlying
asset after useful life would be P 350,000. On this date, the incremental borrowing rate is 5%.

On January 1, 2024, after making the advance lease payment, Viral Company reassessed that it will no longer exercise
the purchase option. The incremental borrowing rate on this date was 7%.

Required:
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
3. Prepare a table of amortization.
4. Prepare the journal entries for 2023.
5. Determine the revised Lease Liability as of January 1, 2024, the date when option will not be exercised.
6. Determine the decrease in Lease Liability as of January 1, 2024 after the reassessment.
7. Determine the revised carrying amount of the Right-of-Use Asset as of January 1, 2024 after the reassessment,
and the revised annual depreciation from year 2024 to year 2026.
8. Prepare the revised table of amortization.
9. Prepare the journal entries for the year 2024.

32
SOLUTION:
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
Answer:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Fixed lease payment less lease incentives, if any
Computation:
b) Guaranteed residual value
c) Bargain purchase option
Computation:
d) Penalties for terminating the lease
Initial Measurement of Lease liability
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset

2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
Answer:
Initial cost of Right-of-Use Asset 4,299,139
Less: Residual Value 350,000
Depreciable cost of Right-of-Use Asset 3,949,139
Divide by useful life in years (reasonably certain for P. Option) 6
Annual depreciation 658,190

Notes:
Although the estimated useful life of the underlying asset is 4 years, the lease term of 6 years is used to depreciate
the ROU Asset because there is a purchase option that is reasonably certain to be exercised by the lessor at the
end of the lease term.

3. Prepare a table of amortization.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 5 %)
0
1
2
3
4
4

Notes:
The P 700,000 purchase option price is included as lease payment because this is included in the computation of the
lease liability at the commencement of the lease contract on January 1, 2023.

33
4. Prepare the journal entries for 2023.
Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of Right of Use Right of Use Asset 4,299,139
Asset and Lease Liability. Lease Liability 4,299,139

Jan. 1 Advance payment of fixed Lease Liability 1,000,000

lease payment for 2023 Cash 1,000,000

Dec. 31 Interest accretion for 2023. Interest Expense 164,957

Interest Payable 164,957

Dec. 31 Annual depreciation of Depreciation Expense 658,190

right of use asset Accumulated Depreciation 658,190

5. Determine the revised amount of the Lease Liability as of January 1, 2024, the date when option will not be exercised.
Answer:
Present value of fixed annual lease payment:
Annual fixed lease payment
Multiply by PVF of an OA of 1 at 7% for 2 periods
Present value of purchase option:
Purchase option price
Present value of Lease Liability at January 1, 2023

Notes:
 The purchase option is now excluded in the computation because this will no longer be exercised.
 As of January 1, 2024, the reassessment date, there are still two lease payments (1/1/2025 and 1/1/2026)
left out of original four payments.
 The next payment will be on January 1, 2025 which is after one year from January 1, 2024 which is the
reassessment date. In effect, the future cash flows will be discounted using the PVF of 7% for remaining two
periods.

6. Determine the decrease in Lease Liability as of January 1, 2024 after the reassessment.
Answer:
Revised PV of remaining lease payment, 1/1/2024
(Refer to requirement 5)
Unadjusted present value of lease liability, 1/1/2024
(refer to table of amortization under requirement 3)
Decrease in Lease Liability, 1/1/2025

7. Determine the revised carrying amount of the Right-of-Use Asset as of January 1, 2024 after the reassessment,
and the revised annual depreciation from year 2024 to year 2026.
Answer:
Carrying amount of ROU Asset, January 1, 2023
Less: Accumulated depreciation during 2023
Computation:
Carrying amount of ROU Asset, before reassessment, 1/1/2024
Less: Decrease in Lease Liability on January 1, 2024
Carrying amount of ROU Asset, after reassessment, 1/1/2024
Divide by remaining lease term in years
Revised annual depreciation from year 2024
34
 Note: The decrease in Lease Liability is also the decrease in Right-of-Use Asset due to their direct relationship. In
effect, the annual depreciation of the ROU Asset will also be revised or adjusted. This is a change in accounting
estimate and the effect is treated in accounting during the current and future periods (prospectively).

8. Prepare the revised table of amortization.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 7 %)
2 January 1, 2024 1,808,018
3 January 1, 2025 1,000,000 126,561 873,439 934,579
4 January 1, 2026 1,000,000 65,421 934,579 0

9. Prepare the journal entries for the year 2024.

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Advance payment of fixed Lease Liability 835,043
lease payment for 2024 Interest Payable 164,957
Cash 1,000,000

Jan. 1 Decrease in lease liability Lease Liability 656,078

due to non-exercise of Right-of-Use Asset 656,078
purchase option.
Dec. 31 Interest accretion for 2024. Interest Expense 126,561
Interest Payable 126,561

Dec. 31 Annual depreciation of Depreciation Expense 994,957

right of use asset Accumulated Depreciation 994,957

PROBLEM 13 (Reassessment of lease term – With Purchase Option from not certain to certain)
Subsequent Decision to Exercise Purchase Option; advance lease payment
(Adapted from Illustration 4 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Santorini Company entered a 5-year lease contract of an underlying asset with a useful life of 8
years for an annual lease payment of P 1,500,000 payable in advance every January 1 starting today. A purchase option
price of P 900,000 was also offered by the lessor. On this date, the incremental borrowing rate was 8% and Santorini
Company was not reasonably certain to exercise the purchase option. The residual value of the underlying asset after
useful life is P 500,000.

On January 1, 2025, Santorini assessed that it is now reasonably certain that it will exercise the purchase option. The
incremental borrowing rate on this date is 10%.

Required:
Use six decimal places for present value factors. Round off your final answer to the nearest peso.
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
3. Prepare a table of amortization.
4. Prepare the journal entries for 2023 and 2024.
5. Determine the carrying amount of the Right-of-Use Asset as of January 1, 2025, the date when decision was made
to exercise the purchase option.
6. Determine the decrease in lease liability on January 1, 2025.

35
7. Determine the revised carrying amount of the Right-of-Use Asset as of January 1, 2025 after the reassessment,
and the revised annual depreciation from year 2025 to year 2030.
8. Prepare the revised table of amortization on January 1, 2025.
9. Prepare the journal entries for the year 2025.

SOLUTION:
1. Determine the present value of Right-of-Use Asset as of January 1, 2023.
Answer:
Lease Liability ROU Asset
Initial measurement of lease liability at present value:
Present value of:
a) Fixed lease payment less lease incentives, if any
Computation:
b) Guaranteed residual value
c) Bargain purchase option
Computation:
d) Penalties for terminating the lease
Initial Measurement of Lease liability
Any lease payments made on or before the commencement
date less any lease incentives
Any initial direct cost incurred by the lessee
Asset retirement obligations at present value:
1) Dismantling cost of the underlying asset
2) Removing cost of the underlying asset
3) Restoration cost of the underlying asset
Initial measurement of Right-of-Use Asset

2. Determine the annual depreciation of Right-of-Use Asset from commencement date of the lease contract.
Answer:
Initial cost of Right-of-Use Asset
Less: Residual Value
Depreciable cost of Right-of-Use Asset
Divide by lease term
Annual depreciation

Notes:
The residual value is not deducted (ignored) from the initial cost of Right-of-Use Asset because the underlying asset
will be transferred to the lessee (Santorini Company) at the end of the lease term. Any residual value will be the
burden of the lessee because the underlying asset will not be regained by the lessor who will also no longer anticipate
to benefit from its residual value.

3. Prepare a table of amortization.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 8 %)
0 6,468,190
1 1,500,000 517,455 5,485,645
2 1,500,000 438,852
3
4
5

36
4. Prepare the journal entries for 2023.
Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of Right of Use
Asset and Lease Liability.

Jan. 1 Advance payment of fixed

lease payment for 2023

Dec. 31 Interest accretion for 2023.

Dec. 31 Annual depreciation of

right of use asset

5. Determine the carrying amount of the Right-of-Use Asset as of January 1, 2025, the date when decision was made
to exercise the purchase option.
Answer:
Present value of fixed annual lease payment:
Annual fixed lease payment
Multiply by PVF of an OA of 1 at 10% for 2 periods
Present value of purchase option:
Purchase option price
Multiply by PVF of 1 at 10% for 3 periods
Present value of Lease Liability and ROU Asset at 1/1/2023
Notes:
 The purchase option is now included in the computation because this will no longer be exercised.
 As of January 1, 2024, the reassessment date, there are still two lease payments (1/1/2026 and 1/1/2027) left out
of original five payments.
 The next payment will be on January 1, 2025 which is after one year from January 1, 2024 which is the reassessment
date. In effect, the future cash flows will be discounted using the PVF of 10% for remaining two periods.

6. Determine the decrease in lease liability on January 1, 2025.

Answer:
Revised PV of remaining lease payment, 1/1/2025
(Refer to requirement 5)
Unadjusted present value of lease liability, 1/1/2025
(refer to table of amortization under requirement 3)
Increase in Lease Liability, 1/1/2025

7. Determine the revised carrying amount of the Right-of-Use Asset as of January 1, 2025 after the reassessment,
and the revised annual depreciation from year 2025 to year 2030.
Answer:
Carrying amount of ROU Asset, January 1, 2023
Less: Accumulated depreciation during 2023 and 2024
Computation:
Carrying amount of ROU Asset, before reassessment, 1/1/2025
Add: Increase in Lease Liability on January 1, 2025
Carrying amount of ROU Asset, after reassessment, 1/1/2025
Less: Residual Value (unguaranteed – Purchase Option now is certain)
Depreciable carrying amount of ROU Asset, 1/1/2025
Divide by remaining useful life in years
Revised annual depreciation from year 2025

37
 Notes:
The increase in Lease Liability is also the increase in Right-of-Use Asset due to their direct relationship. In effect, the
annual depreciation of the ROU Asset will also be revised or adjusted. This is a change in accounting estimate and
the effect is treated in accounting during the current and future periods (prospectively).
The remaining useful life will now be used to determine the revised annual depreciation because of the exercise
of purchase option wherein the ownership of underlying asset will be transferred to Santorini Company at the end of
the lease term.
The residual value is now deducted from the revised carrying amount of the underlying asset after the
reassessment because this will now be absorbed by the lessee.

8. Prepare the revised table of amortization on January 1, 2025.

Answer:
Lease Payment and Lease Liability
Interest Accretion Lease Interest Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 10 %)
3 January 1, 2025 3,279,490
4 January 1, 2026
5 January 1, 2027
6 December 31, 2027

Notes:
The P 900,000 purchase option price is included as lease payment because this is included in the computation of the
lease liability at the commencement of the lease contract on January 1, 2023.

9. Prepare the journal entries for the year 2025 and 2026.
Answer:
Date Transactions Account Names Debit Credit
2025
Jan. 1 Advance payment of fixed Lease Liability 1,190,748
lease payment for 2025 Interest Payable 309,252
Cash 1,500,000

Jan. 1 Increase in lease liability Right-of-Use Asset 604,593

due to non-exercise of Lease Liability 604,593
purchase option.
Dec. 31 Interest accretion for 2025. Interest Expense 327,949
Interest Payable 327,949

Dec. 31 Annual depreciation of Depreciation Expense 664,251

right of use asset Accumulated Depreciation 664,251

PROBLEM 14 (Reassessment of the Variable Lease Payment Not Based on Rate or Index) - IFRS
(Adapted from Problem 11-2 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Gold Company entered into a 5-year lease of a floor of a building with the following terms:

Annual rental for the first two years payable at the end of each year 200,000
Annual rental for the next three years payable at the end of each year 300,000
Useful life of building 20 years
Implicit interest rate 8%
PV of an ordinary annuity of 1 at 8% for two periods 1.78
PV of an ordinary annuity of 1 at 8% for three periods 2.58
PV of 1 at 8% for two periods 0.86
38
Required (Use six decimal places for PVF):
1. Determine the initial measurement of lease liability at January 1, 2024.
2. Determine the annual depreciation.
3. Prepare the amortization table.
4. Prepare journal entries for 2024, 2025 and 2026.

SOLUTION:
1. Determine the initial measurement of lease liability at January 1, 2024.
Answer:
Present value of thew original lease payment:
Annual original lease payment (2024, 2025)
Multiply by PVF of an ordinary annuity 1 at 8% for 2 periods
Present value of escalated lease payment: (2026, 2027, 2028)
Annual escalated lease payment
Multiply by PVF of an ordinary annuity 1 at 8% for 3 periods
Present value at January 1, 2026
Multiply by PV of 1 at 8% for two periods
Present value of Lease Liability at January 1, 2024

2. Determine the annual depreciation.

Answer:
Initial cost of Right-of-Use Asset
Divide by useful life (UL is shorter than lease term)
Annual depreciation

Notes: The problem is silent. Therefore, it is assumed that there is no transfer of ownership to the lessee at the
end of the lease term. In effect, the useful of 5 years of the underlying asset will be used for depreciation purposes
because this is shorter than the lease term of 20 years.

3. Prepare the amortization table.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 8 %)
January 1, 2024
1 December 31, 2024
2 December 31, 2025
3 December 31, 2026
4 December 31, 2027
5 December 31, 2028

4. Prepare journal entries for 2024, 2025 and 2026.

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Recognition of Right of Use Right of Use Asset 1,021,640
Asset and Lease Liability. Lease Liability 1,021,640

Dec. 31 Payment of lease payment Interest Expense 81,731

for 2024. Lease Liability 118,269
Cash 200,000

Dec. 31 Annual depreciation of Depreciation Expense 204,328

right of use Accumulated Depreciation 204,328

39
 2025
Dec. 31 Payment of lease payment Interest Expense 72,270
for 2025. Lease Liability 127,730
Cash 200,000

Dec. 31 Annual depreciation of Depreciation Expense 204,328

right of use Accumulated Depreciation 204,328

2026
Dec. 31 Payment of lease payment Interest Expense 62,051
for 2026. Lease Liability 237,949
Cash 300,000

Dec. 31 Annual depreciation of Depreciation Expense 204,328

right of use Accumulated Depreciation 204,328

PROBLEM 15 (Reassessment of the Variable Lease Payment Based on Rate or Index)

(Adapted from Illustration 6 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Mindanao Company entered into a six-year lease contract covering an office space at annual lease
payments of P 2,100,000 starting January 1, 2023. The lease payments will be adjusted starting January 1, 2026
using the change in consumer price index (CPI) from January 1, 2023 to January 1, 2025. Incremental borrowing rate as
of this date was 6%. Consumer Price Indices (CPI) as of January 1, 2023 and 2025 were 120 and 150, respectively.
Incremental borrowing rates as of January 1, 2025 was 8%.
Requirement (Use six decimal places for PVF):
1. Determine the lease liability at January 1, 2023 and the annual depreciation of the Right-of-Use Asset.
2. Prepare the amortization table.
3. Determine the annual lease payment on January 1, 2025 as reassessed based on the new consumer price index.
4. Determine the increase in lease liability as of January 1, 2025.
5. Determine the revised annual depreciation from year 2025 to year 2027.
6. Prepare the revised amortization table.
7. Prepare the journal entries for 2025 and 2026.
SOLUTION:
1. Determine the lease liability at January 1, 2023 and the annual depreciation of the Right-of-Use Asset.
Answer:
Present value of the Annual Lease Payments:
Annual lease payment
Multiply by PVF of an annuity due 1 at 6% for 6 periods
Present value of Lease Liability at January 1, 2023
Divide by lease term in years (no useful life is given)
Annual depreciation of ROU Asset

2. Prepare the amortization table.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 6 %)
January 1, 2023
1 January 1, 2023
2 January 1, 2024
3 January 1, 2025
4 January 1, 2026
5 January 1, 2027
6 January 1, 2028
40
3. Determine the annual lease payment on January 1, 2025 as reassessed based on the new consumer price index.
Answer:
Revised Lease Unrevised Lease Index as of revision date
= x
Payments Payments (base) Index as of commencement date
150
= 2,100,000 x
120
= 2,100,000 x 1.25
=

4. Determine the increase in lease liability as of January 1, 2025.

Answer:
Present value of the Annual Lease Payments:
Revised annual lease payment based on CPI
Multiply by PVF of ordinary annuity 1 at 6% for 3 periods
Revised PV of Lease Liability at January 1, 2025 (12/31/2024)
Less: Unadjusted PV of Lease Liability, at 1/1/2025 (12/31/2024)
(Refer to Table of Amortization in number 2)
Increase in Lease Liability, 1/1/2025 (12/31/2024)
Notes:
The reassessment actually happened on December 31, 2024 because it is assumed that the 150 CPI as of January 1, 2025
is the CPI at the beginning of the year 2025. The discount rate used is the 6% incremental borrowing rate as of
commencement date since the trigger is the change in variable lease payments based on index or rate. The period
is 3 years because out of 6 payments, the remaining payments to be made would be 3 years from 20245 to 2027.

5. Determine the revised annual depreciation from year 2025 to year 2027.
Answer:
Carrying amount of ROU Asset, January 1, 2023
Less: Accumulated depreciation during 2023 and 2024
Computation:
Carrying amount of ROU Asset, before reassessment, 12/31/2024
Add: Increase in Lease Liability on January 1, 2025
Carrying amount of ROU Asset, after reassessment, 1/1/2025
Divide by remaining lease term in years
Revised annual depreciation from year 2025

6. Prepare the revised amortization table.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 6 %)
3 January 1, 2025 2,100,000 436,603 1,663,397 5,613,325
3 January 1, 2025
4 January 1, 2026
5 January 1, 2027
6 January 1, 2028

41
7. Prepare the journal entries for 2025 and 2026.
Answer:
Date Transactions Account Names Debit Credit
2025
Jan. 1 Increase in lease liability
due to change in CPI.

Jan. 1 Advance payment of lease

payment for 2025.

Dec. 31 Interest accrual at end of

2025.

Dec. 31 Annual depreciation of

right of use

2026
Jan. 1 Advance payment of lease
payment for 2026.

Dec. 31 Annual depreciation of

right of use

Dec. 31 Interest accrual at end of

2026.

PROBLEM 16 (Lease Modification – Increase in the Scope of the Lease)

(Adapted from Illustration 7 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Romania Company entered into a five-year lease of 4,000 square meters of office space for annual
lease payment of P 800,000 (or P 200 per square meter), due immediately. Incremental borrowing rate as of this date is
5%.

On January 1, 2024, after paying the lease due for the year, the company and the lessor modified the lease contract by
including an additional 3,000 square meters of office space over the remaining four-year lease term, with the additional
lease payment due immediately. Incremental borrowing rate is 7% as of this date.
Required (Use six decimal places for PVF):
Assuming the annual lease payment for additional 3,000 square meters was set at P 600,000:
1. Determine the lease liability at January 1, 2023 and the annual depreciation of the Right-of-Use Asset.
2. Prepare the amortization table.
3. Journal entries for 2023.
4. Determine the additional lease liability on January 1, 2024 and the additional annual depreciation due to increase in
scope of the lease.
5. Prepare the amortization table for the additional 3,000 square meters.
6. Journal entries for 2024.

42
SOLUTION:
1. Determine the lease liability at January 1, 2023 and the annual depreciation of the Right-of-Use Asset.
Answer:
Present value of the Annual Lease Payments (4,000 sqm.):
Annual lease payment
Multiply by PVF of an annuity due 1 at 5% for 5 periods
Present value of Lease Liability at January 1, 2023
Divide by lease term in years (no useful life is given)
Annual depreciation of ROU Asset

2. Prepare the amortization table.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 5 %)

1
2
3
4
5

3. Journal entries for 2023:

Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of lease
liability and ROU Asset
(4,000 sqm.)
Jan. 1 First advance lease
payment for 2023 (4,000
sqm.)
Dec. 31 Annual depreciation of
right of use asset

Dec. 31 Interest accrual at end of

2023.

4. Determine the additional lease liability on January 1, 2024 and the additional annual depreciation due to increase in
scope of the lease.
Answer:
Present value of the new Annual Lease Payments (3,000 sqm.):
Annual lease payment
Multiply by PVF of an annuity due 1 at 7% for 4 periods
Present value of new Lease Liability at January 1, 2024
Divide by remaining lease term in years
Annual depreciation of ROU Asset (additional)

Notes:
The increase in scope is accounted separately from the original scope since the additional P 600,000 annual lease
payment commensurate with the stand-alone price of the office price which is P 200 per square meter. To
check, P 600,000 additional annual lease payment divide by 3,000 square meters equals P 200 per square meter.

43
 The number of periods of this additional annual lease payment is no longer 5 years but four years (the remaining
lease term). Since considered separately, the incremental borrowing rate to be used is as of January 1, 2024 which
is 7%.

5. Prepare the amortization table for the additional 3,000 square meters.
Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 7 %)

1
2
3
4

6. Journal entries for 2024.

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Second advance lease Lease Liability 658,162
payment for 2023 (4,000 Interest Payable 141,838
sqm.) Cash 800,000

Jan. 1 Initial recognition of lease Right of Use Asset 2,174,590

liability and ROU Asset Lease Liability 2,174,590
(3,000 sqm.)
Jan. 1 First advance payment Lease Liability 600,000
lease payment for 2024 Cash 600,000
(3,000 sqm.)
Dec. 31 Annual depreciation of Depreciation Expense 727,352
right of use asset (4,000 Accumulated Depreciation 727,352
sqm.)
Dec. 31 Annual depreciation of Depreciation Expense 543,648
right of use asset (3,000 Accumulated Depreciation 543,648
sqm.)
Dec. 31 Interest accrual at end of Interest Expense 108,930
2024 (4,000 sqm.) Interest Payable 108,930

Dec. 31 Interest accrual at end of Interest Expense 110,221

2024 (3,000 sqm.) Interest Payable 110,221

PROBLEM 17 (Lease Modification – Increase in the Scope of the Lease)

(Adapted from Illustration 7 from Intermediate Accounting Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
Using the same information in Problem 17, except that the annual lease payments for additional 3,000 square meters
was set at P 360,000. (not equal to rental/ sqms = P 120 per square meter)

Required (Use six decimal places for PVF):

1. Determine the increase in lease liability on January 1, 2024
2. Determine the revised annual depreciation due to increase in scope of the lease.
3. Prepare the amortization table.
4. Journal entries for 2023 and 2024.

44
SOLUTION:
1. Determine the increase in lease liability on January 1, 2024
Answer:
Present value of the original Annual Lease Payments (4,000 sqm):
Annual lease payment
Multiply by PVF of ordinary annuity at 7% for 3 periods
Present value of the new Annual Lease Payments (3,000 sqm.):
Annual lease payment
Multiply by PVF of annuity due at 7% for 4 periods
Revised present value of Lease Liability at January 1, 2024
Less: Unadjusted PV of Lease Liability at January 1, 2024 (4,000)
(See table of amortization in number 2 of Problem 17)
Increase in Liability at January 1, 2024

Notes:
The remaining lease payment for original lease term (4,000 square meters) is 5 years. The last two payments made were
on January 1, 2023 and January 1, 2024. Therefore, its remaining lease term is 3 years.
The new lease term has a term of 4 years based on original lease term of 5 years. As of January 1, 2024, only one year
was expired from original lease term.
The new incremental borrowing rate of 7% is used because the trigger is the lease modification.

2. Determine the revised annual depreciation due to increase in scope of the lease.
Answer:
Carrying amount of ROU Asset, January 1, 2023
Less: Accumulated depreciation during 2023 and 2024
Computation:
Carrying amount of ROU Asset, before reassessment, 12/31/2023
Add: Increase in Lease Liability on January 1, 2024
Carrying amount of ROU Asset, after reassessment, January 1, 2024
Divide by remaining lease term in years
Revised annual depreciation from year 2024 (7,000 sqm.)
Notes:
The remaining lease term is 4 years from January 1, 2024. The original lease term is 5 years from January 1, 2023.

3. Prepare the revised amortization table.

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Carrying
Year Dates Payment (Accretion) Amortization Amount
(CA x 7 %)
2 January 1, 2024 2,178,599
2 January 1, 2024
3 January 1, 2025
4 January 1, 2026
5 January 1, 2027

Notes:
The annual lease payment is ____________ = P __________ (4,000 sqm.) + P _________ (3,000 sqm.)

45
4. Journal entries for 2023 and 2024
Answer:
Date Transactions Account Names Debit Credit
2023
Jan. 1 Recognition of lease
liability and ROU Asset
(remeasurement.)
Jan. 1 First advance lease
payment for 2023 (4,000
sqm.)
Dec. 31 Annual depreciation of
right of use asset

Dec. 31 Interest accrual at end of

2023.

Date Transactions Account Names Debit Credit

2024
Jan. 1 Second advance lease
payment for 2023 (4,000
sqm.)

Jan. 1 Increase in lease liability

(remeasurement)

Jan. 1 First advance lease

payment (3,000 sqm.)

Dec. 31 Annual depreciation of

right of use asset (7,000
sqm.)
Dec. 31 Interest accrual at end of
2024 (7,000 sqm.)

-------
SUPPLEMENTAL PROBLEM 1 (Lease Modification – Increase in the Scope of the Lease) - IFRS
(Adapted from Problem 11-3 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Silver Company entered into a lease agreement with the following information:

Floor space 150 square meters

Annual rental payable at the end of each year 200,000
Implicit rate in the lease 12%
Lease term 12 years
PV of an ordinary annuity at 12% for 12 periods 6.19

On January 1, 2027, Silver Company and the lessor agreed to amend the original terms of the lease with the following
information:

Additional floor space 200 square meters

Increase in rental payable at the end of each year 300,000
Implicit rate in the lease 10%
PV of an ordinary annuity at 10% for 9 periods 5.76

46
Required:
1. Prepare journal entries for 2024.
2. Prepare journal entries for 2027 pertaining to the lease of additional floor space.

SOLUTION:
A. Present value of right of use/lease liability (150 square meters)
Answer:
Present value of fixed lease payment:
Annual fixed lease payment 200,000
Multiply by PVF of an ordinary annuity 1 at 12% for 12 periods 6.19
Present value at January 1, 2024 (original agreement) 1,238,000

B. Annual depreciation of Right of Use Asset (150 square meters)

Answer:
Present value at January 1, 2024 (See Letter A) 1,238,000
Divide by lease term (no useful life given) 12
Annual depreciation 103,167

C. Table of amortization of Lease Liability (150 square meters)

Answer:
Lease Payment and Interest Lease Liability
Interest Accretion Lease Expense Amortization Carrying
Dates Payment (Accretion) Amount
(CA x ER 12 %)
January 1, 2024 1,238,000
December 31, 2024 200,000 148,560 51,440 1,186,560
December 31, 2025 200,000 142,387 57,613 1,128,947
December 31, 2026 200,000 135,474 64,526 1,064,421
December 31, 2027 200,000 127,731 72,269 992,152

1. Prepare journal entries for 2024.

Answer:
Date Transactions Account Names Debit Credit
2022
Jan. 1 Recognition of Right of Use Right of Use Asset 1,238,000
Asset and Lease Liability Lease Liability 1,238,000
(150 square meters).
Dec. 31 Payment of fixed lease Interest Expense 148,560
payment for 2022. Lease Liability 51,440
Cash 200,000

Dec. 31 Annual depreciation of Depreciation Expense 103,167

right of use Accumulated Depreciation 103,167

2. Prepare journal entries for 2027 pertaining to the leas of additional floor space.
A. Present value of right of use/lease liability (200 square meters)
Answer:
Present value of fixed lease payment:
Annual fixed lease payment 300,000
Multiply by PVF of an ordinary annuity 1 at 10% for 9 periods 5.76
Present value at January 1, 2025 1,728,000

Notes:
It is based on 9 periods (12 years original lease term – 3 years passed)

47
B. Annual depreciation of Right of Use Asset (200 square meters)
Answer:
Present value at January 1, 2024 (See Letter A) 1,728,000
Divide by remaining lease term (12 years – 3 years) 9
Annual depreciation 192,000

C. Table of amortization of additional lease liability (200 square meters)

Answer:
Date Lease Interest Expense Principal CA of Lease
Payment Payment Liability
(CA x ER 10 %)
January 1, 2027 1,728,000
December 31, 2027 300,000 172,800 127,200 1,600,800
December 31, 2028 300,000 160,080 139,920 1,460,880

Note:
IFRS 16, paragraph 44, provide that the lessee shall account for the lease modification as a separate lease like
if the modification increases the scope of the lease by adding the right to use an underlying asset.

Date Transactions Account Names Debit Credit

2027
Jan. 1 Additional Right of Use Right of Use Asset 1,728,000
Asset and Lease Liability Lease Liability 1,728,000
for 200 square meters.
Dec. 31 Payment of fixed lease Interest Expense 172,800
payment for 2025 (for Lease Liability 127,200
200 square meters) Cash 300,000

Dec. 31 Annual depreciation of Depreciation Expense 192,000

right of use (200 square Accumulated Depreciation 192,000
meters) (P 1,728,000 / 9 years)

Date Transactions Account Names Debit Credit

2027
Dec. 31 Payment of fixed lease Interest Expense 127,731
payment for 2025 (for Lease Liability 72,269
150 square meters) Cash 200,000

Dec. 31 Annual depreciation of Depreciation Expense 103,167

right of use (150 square Accumulated Depreciation 103,167
meters) (P 1,238,000 / 12 years)

48
 PROBLEMS – ACCOUNTING FOR LESSOR
Identifying the Accounting Model

PROBLEM 18 (Identifying the Lease Model)

Cocoon Company purchased a machinery at a cost of P 10,000,000 with estimated useful life of 10 years. This machinery
was immediately leased out for 4 years. Based on lease contract, the lessee has the option to purchase the machinery at
P 400,000. Required: Identify the appropriate lease accounting model to be applied by the lessee:

Accounting Model Finance Lease Criteria

No. Situations To Be Used Reference(s) Conclusion
1 The expected value Finance lease Determinative criterion no. 3 – Failed. It passed the
of the machinery at 4 years lease term / 10 years useful life determinative criteria
the end of the lease is only 40%. no. 2, it will apply
term is P 1,000,000. finance lease,
Determinative criterion no. 2 – Passed although is failed the
On the contrary, the purchase option of determinative criteria
P 400,000 is lower than the expected no. 3. Use finance
value (fair value) of P 1,000,000 at the lease.
end of the lease term.

2 The expected value Operating Lease Determinative criterion no. 3 – Failed. It failed the
of the machinery at 4 years lease term / 10 years useful life determinative criteria
the end of the lease is only 40%. nos. 2 and 3. Use
term is P 200,000. operating lease.
Determinative criterion no. 2 – Failed
The purchase option of P 400,000 is
higher than the expected value (fair
value) of P 200,000 at the end of the
lease term. Therefore, this is not a
bargain purchase option.

3. Assuming no Operating lease Determinative criterion no. 3 – Failed. It failed the

purchase option is 4 years lease term / 10 years useful life determinative
given. is only 40%. criterion no. 3. Use
operating lease.

4. Assuming no Finance lease Determinative criterion no. 4 – Passed The % of PV to FV of

purchase option but PV of lease payment: the machinery is
the annual lease P 1,500,000 x 3.6243 = P 5,436,450 90.61% which is
payment is P more than 90%.
1,500,000 which is % of PV to fair value: Therefore, it is
payable in advance. P 5,436,450/P 6,000,000 = 90.61% substantially all of the
Implicit interest rate fair value. Use
is 7%. The fair value Determinative criterion no. 3 – Failed. finance lease
of the machinery is 4 years lease term / 10 years useful life
P 6,000,000. Use is only 40%.
four decimal places
in rounding off.

5. The same Operating lease Determinative criterion no. 4 – Failed The % of PV to FV of

information in PV of lease payment: the machinery is
number 4 except P 1,500,000 x 3.6243 = P 5,436,450 83.64% which is less
that the fair value of than 90%. Therefore,
the machinery is P % of PV to fair value: it is not substantially
6,500,000. P 5,436,450/P 6,500,000 = 83.64% all of the fair value.
Use operating
Determinative criterion no. 3 – Failed lease

49
 PROBLEMS – ACCOUNTING FOR LESSOR
Operating Lease Model

PROBLEM 19 (Operating Lease Model) - PHILCPA Adapted

(Adapted from Problem 12-1 from Intermediate Accounting Vol. 1, 2022 Edition by Valix, Peralta, Valix)
On January 1, 2024, Vim Company purchased an equipment for P 3,000,000 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, 2024, the equipment was leased to Eloisa Company for a three-year period at a monthly rental of P 40,000
payable at the end of every month. Additionally, Eloisa Company paid P 120,000 to Vim Company on April 1, 2024 as a
lease bonus. Vim Company paid repairs of P 20,000 during 2024.

Required:
1. Prepare journal entries on the books of the lessor following the operating lease model.
2. Compute the net rent income of the lessor for 2024

SOLUTION GUIDE:
1. Journal entries on the books of the lessor following the operating lease model.
Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Acquisition of equipment Equipment
Equipment 3,000,000
3,000,000
for cash. Cash
Cash 3,000,000
3,000,000

Apr. 1 Collection of lease bonus Cash 120,000

120,000
from the Eloisa Company. Unearned
UnearnedRent
RentIncome
Income 120,000
120,000

April 31 Collection of rent income Cash 360,000

360,000
to for 9 months. RentIncome
Rent Income 360,000
360,000
Dec. (P 40,000
( 40,000 per month x 9 months)
x 9mos)

Dec. 31 Depreciation of machinery Depreciation

Dep Exp 300,000
300,000
AccumulatedDep
Accumulated Depreciation 300,000
300,000
(3M (P
x 1/10)
3,000,000 / 10 years)

Dec. 31 Amortization of lease Unearned Rent

Unearned RentIncome
Income 30,000
30,000
bonus over the lease term Rent Income
Rent Income 30,000
30,000
(120k
(Px120,000
9/36) / 3 years x 9/12)

Dec. 31 Payment of repair during Repairs

Repairs and MaintenanceExpense
and Maintenance 20,000
20,000
the year Cash 20,000
20,000

Notes:
The depreciation of machinery for the year 2024 is for 1 year which is from acquisition date of January 1 to December 31
and not from commencement date of the lease.

2. Computation of the net rent income of the lessor for 20224

Answer:
Rent Income from lease payment 360,000
Rent income from lease bonus 30,000
Total rent income for the year 2024 390,000
Less: Expenses
Depreciation 300,000
Repairs and Maintenance 20,000 (320,000)
Net rent income for 2024 70,000

50
PROBLEM 20 (Operating Lease with Computation of Net Income)
(Adapted from Problem 12-2 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Dorey Company purchased a machine for P 5,000,000 for the express purpose of leasing it.

The machine was expected to have a 10-year life with no residual value and the straight-line method of depreciation is
used.

On March 1, 2024, Dorey Company leased the machine to a lessee for P 1,200,000 a year for 4-year period ending
February 28, 2028.

Dorey Company paid a total of P 60,000 for maintenance and received P 1,200,000 from the lessee on March 1, 2024.

Dorey Company retained title to the property and planned to lease it to someone else after the 4-year lease period.

Required:
1. Prepare journal entries on the books of Dorey Company.
2. Determine the net rent income of Dorey Company.

SOLUTION:
1. Journal entries on the books of Dorey Company.
Answer:
Date Transactions Account Names Debit Credit
2024
Jan. Purchase of machinery. Machinery 5,000,000
5,000,000
Cash
Cash 5,000,000
5,000,000

Mar. 1 Advance collection of Cash

Cash 1,200,000
1,200,000
lease payment. Rent
Rent Income
Income 1,200,000
1,200,000

Mar. 1 Payment for repairs and Repairs and

Repairs and Maintenance
MaintenanceExpense 60,000
60,000
maintenance. Cash
Cash 60,000
60,000

Dec. 31 Recognition of Unearned Rent Income

Rent Income 200,000
200,000
Rent Income at year Unearned
UnearnedRent Income
Rent Income 200,000
200,000
end. (1.2M x 2/12) x 2/12)
(P 1,200,000

Dec. 31 Depreciation of Depreciation

Depreciation Expense 500,000
500,000
machinery at during the Accumulated
Accumulated Depreciation
Depreciation 500,000
500,000
year. (5M
(P x5,000,000
12/120) / 10 years x 1 year)

*May also use Lease Expense account.

2. Determination of the net rent income of Dorey Company.

Answer:
Rent income, unadjusted 1,200,000
1,200,000
Less: Unearned rent income 200,000
Rent income, adjusted 1,000,000
Less: Expenses
Repairs and Maintenance 60,000
Depreciation Expense 500,000 560,000
Net Rent Income 440,000

51
PROBLEM 21 (Operating Lease with Computation of Net Income) –AICPA Adapted
(Adapted from Problem 12-1 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On March 31, 2024, Barnes Company purchased a machine for P 2,400,000 for the purpose of leasing it.

The machine is expected to have a 10-year life and no residual value and will be depreciated over the straight-line
basis.

The machine was leased on April 1, 2024 for four years at a monthly rental of P 40,000.

There is no provision for renewal of the lease or purchase of the machine by the lessee upon expiration of the lease.

Barnes Company paid P 240,000 initial direct costs associated with negotiating the lease in March 2024.

Required:
1. Prepare journal entries on the books of the lessor for 2024.
2. Present the machinery in the statement of financial position of Barnes Company on December 31, 2024.

SOLUTION:
1. Journal entries on the books of the lessor for 2024.
Answer:
Date Transactions Account Names Debit Credit
2024
Mar. 31 Purchase of machinery. Machinery 2,400,000
2,400,000
Cash
Cash 2,400,000
2,400,000

Apr. 1 Collection of lease Cash

Cash (P 40,000 x 9 months) 360,000
To payment. Rent Income
Rent Income 360,000
Dec. 31
Apr. 1 Payment of Deferred
Cash initial direct costs 240,000
initial direct costs. Cash IDC
Deferred 240,000

Dec. 31 Amortization of deferred Amortization of initial direct costs 45,000

initial direct costs. Deferred initial direct costs 45,000
(P 240,000 / 4 years x 9/12)

Dec. 31 Depreciation of Depreciation 180,000

machinery at during the Accumulated Depreciation 180,000
year. (P 2,400,000 / 10 years x 9/12)

2. Presentation of the machinery in the statement of financial position of Barnes Company on December 31, 2024,
2025 and 2026.
Answer:
12/31/2024 12/31/2025 12/31/2026
Noncurrent asset:
Machinery
Less: Accumulated Depreciation
Carrying amount
Add: Deferred Initial Direct Cost
Adjusted carrying amount

*Net Rent Income =

52
PROBLEM 22 (With Free Rentals Periods) – AICPA Adapted
(Adapted from Problem 12-3 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
As an inducement to enter a lease, Aris Company, a lessor, granted a lessee nine months of free rent under a five-year
operating lease. The lease is effective on April 1, 2024 and provided for monthly rental of P 100,000 to begin January
1, 2025.

Required:
Prepare journal entries on the books of Aris Company over the 5-year lease term.

SOLUTION:
Date Transactions Account Names Debit Credit
2024
Apr. 1 Accrual of rent income Rent Receivable* 765,000
for year 1 (4/1 to Rent Income (P 1,020,000 x 9/12) 765,000
12/31 – free)
2025
Jan. 1 Collection of rental Cash 1,200,000
income for year 1 Rent Income 1,020,000
Rent Receivable 180,000

2026
Jan. 1 Collection of rental Cash 1,200,000
income for year 2 Rent Income 1,020,000
Rent Receivable 180,000

2027
Jan. 1 Collection of rental Cash 1,200,000
income for year 3 Rent Income 1,020,000
Rent Receivable 180,000

2028
Apr. 1 Collection of rental Cash 1,200,000
income for year 4 Rent Income 1,020,000
Rent Receivable 180,000

2029
Apr. 1 Collection of rental Cash (P 100,000 x 3 months) 300,000
income for year 5 (1/1 Rent Income (P 1,020,000 x 3/12) 255,000
to 4/1 – 3 months) Rent Receivable 45,000

*Supporting computation:
51 months (P 100,000 x 51 months)
Total Rent income for ____ 5,100,000
5,100,000

Average annual rent for 5 years (P 5,100,00 / 5 years) 1,020,000

Rent income for year 2024 (P 1,020,000 x 9/12) 765,000

Year 1: April 1, 2024 to March 31, 2025

(12 months – 9 months free) 3
Year 2: April 1, 2023 to March 31, 2026 12
Year 3: April 1, 2024 to March 31, 2027 12
Year 4: April 1, 2025 to March 31, 2028 12
Year 5: April 1, 2026 to March 31, 2029 12
Total number of months with actual rent income 51
53
PROBLEM 23 (Unequal Rental Payments) – AICPA Adapted
(Adapted from Problem 12-5 from Intermediate Accounting Vol. 1, 2024 Edition by Valix, Peralta, Valix)
On January 1, 2024, Gee Company leased a building to a lessee under a 3-year operating lease.

and P 350,000 monthly for 2026. All payments were made when due.
·
Total rent for the term of the lease was P 7,200,000, payable P 100,000 monthly for 2022,
4 P 150,000 monthly for 2025,

Required:
1. Compute the average annual rental.
2. Prepare journal entries on the books of Gee Company over the three-year lease term.

SOLUTION:
1. Compute the average annual rental.
Answer:
Year 2024: P 100k per month x 12 months 1,200,000
1,200,000
Year 2025: P 150k per month x 12 months 1,800,000
1,800,000
Year 2026: P 350k per month x 12 months 4,200,000
4,200,000
Total rent income for 3 years or 36 months 7,200,000
7,200,000
Divide by 3 years 3
/3
Average annual rental 2,400,000
2,400,000

Notes:
Under IFRS, where the operating lease requires unequal cash payments, the total cash payments for the lease term
shall be amortized uniformly on a straight-line basis as rent income over the lease term.

2. Prepare journal entries on the books of Gee Company over the three-year lease term.
Answer:
Date Transactions Account Names Debit Credit
2024
Dec. 31 Collection of year Cash
Cash 1,200,000
1,200,000
2022 rent income RentReceivable
Rent Receivable 1,200,000
1,200,000
already due. Rent
RentIncome
Income 2,400,000
2,400,000

2025
Dec. 31 Collection of year Cash
Cash 1,800,000
1,800,000
2023 rent income Rent Receivable
Rent 600,000
600,000
already due. Rent Income
Rent Income 2,400,000
2,400,000

2026
Dec. 1 Collection of year Cash 4,200,000
4,200,000
2024 rent income Rent
Rent Income
Receivable 2,400,000
1,800,000
already due. Rent
Rent Receivable
Income 2,400,000
1,800,000

PROBLEM 24 (With Free Rental Period and Variable Lease Payments)

(Adapted from Chapter 10 - Illustration 2 from IA Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Emerald Company entered into a four-year lease contract covering a commercial space by agreeing
to receive annual lease payments of P 3,000,000 plus 2% of its annual sales every December 31 of each year. The
company will also charge additional P 200,000 per year for the security services it will provide in the premises. It was
also agreed to reduce by 50% the annual lease payments for 2025 and 2026, but retaining the 2% variable lease
payments, as part of its promotional campaign. The sales revenue of the lessee for the years 2023, 2024, 2025 and 2026
were P 20,000,000, P 22,000,000, P 18,000,000 and P 23,000,000, respectively. The lease is accounted for as an
operating lease.

54
Required:
1. Determine the average annual fixed rental income.
2. Determine the fixed portion and variable portion of annual rent income.
3. Prepare the journal entries for the years 2023, 2024, 2025, and 2026.

SOLUTION:
1. Determine the average annual fixed rental income.
Answer:
Annual fixed income received:
Year 2023 3,000,000 3,000,000
3,000,000
Year 2024 3,000,000 3,000,000
3,000,000
3,000,000
Year 2025 (P ___________ 50
x ___%) 1,500,000
1,500,000
3,000,000
Year 2026 (P ___________ 50
x ___%) 1,500,000
1,500,000
Total fixed rental payments during lease term 9,000,000
9,000,000
Divide by lease term in years /4
Average annual fixed rental income 2,250,000
2,250,000

2. Determine the fixed portion and variable portion of annual rent income.
Answer: Dr. Cash
Rent Income received Rent Income Earned Unearned Rent Income
Year Fixed Variable Total Fixed Variable Total Fixed Variable
2023 3,000,000 400,000 3,400,000 2,250,000 400,000 2,650,000 750,000
2024 3,000,000 440,000 3,440,000 2,250,000 440,000 2,690,000 750,000
2025 1,500,000 360,000 1,860,000 2,250,000 360,000 2,610,000 750,000
2026 1,500,000 460,000 1,960,000 2,250,000 460,000 2,710,000 750,000
9,000,000
Notes:
a) Fixed rent income from 2025 to 2026 are reduced to 50% or P 1,500,000 (P 3,000,000 x 50%).
b) Variable rent income is based on annual sales:
20M
1. Year 2023 = P ____________ 400,000
x 2% = P ___________
22M
2. Year 2024 = P ____________ x 2% = P ___________
440,000
18M
3. Year 2025 = P ____________ x 2% = P ___________
360,000
23M
4. Year 2026 = P ____________ x 2% = P ___________
460,000

3. Prepare the journal entries for the years 2023, 2024, 2025, and 2026.
Answer:
Date Transactions Account Names Debit Credit
2023
Dec. 31 Collection of annual Cash 3,400,000
3,400,000
rent income for Rent
Rent Income
Income 2,650,000
2,650,000 **If lacks debit, Dr.
2023. Unearned
UnearnedRentRent
Income
Income 750,000
750,000 Rent Receivable

Dec. 31 Collection of Cash

Cash 200,000
200,000
security services Other Income
Other Income 200,000
200,000
payment for 2023

Date Transactions Account Names Debit Credit

2024
Dec. 31 Collection of annual Cash 3,440,000
3,440,000
rent income for Rent Income
Unearned Rent Income 750,000
2,690,000
2024. Unearned
Rent Income Rent Income 2,690,000
750,000

Dec. 31 Collection of Cash 200,000

200,000
security services Other Income
Other Income 200,000
200,000
payment for 2024.
55
 Date Transactions Account Names Debit Credit
2025
Dec. 31 Collection of annual Cash 1,860,000
1,860,000
rent income for Unearned RentIncome
Unearned Rent Income 750,000
750,000
2025. Rent
Rent Income
Income 2,610,000
2,610,000

Dec. 31 Collection of Cash 200,000

200,000
security services Other Income
Other Income 200,000
200,000
payment for 2025.

Date Transactions Account Names Debit Credit

2026
Dec. 31 Collection of annual Cash
Cash 1,960,000
1,960,000
rent income for UnearnedRent
Unearned RentIncome
Income 750,000
750,000
2026. Rent
Rent Income
Income 2,710,000
2,710,000

Dec. 31 Collection of Cash

Cash 200,000
200,000
security services Other Income
Other Income 200,000
200,000
payment for 2026.

PROBLEM 25 (Lease of land and building together)

(Adapted from Chapter 10A - Illustration 4 from IA Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2024, a lessor leased out for five years one of its office buildings, together with the land on which the
building sits, to a single lessee in a single lease contract. The carrying amount of land is P 1,800,000 while the building
has carrying amount of P 2,700,000. Advance annual lease payment for this lease amounted to P 1,007,815. Leasehold
interest over land and building have fair values of P 2,000,000 and P 3,000,000 respectively. Implicit rate was 6%.

Required:
Under each of the following independent scenarios, determine the accounting for the annual lease payments of P
1,007,815: (use six decimal places for PV factors)
1) The lease of building component is classified as finance lease, while the land component is operating lease.
2) Both the lease of building and the lease of land are classified as finance lease.
3) Both the lease of building and the lease of land are classified as operating lease.

SOLUTION:
1) The lease of building component is classified as finance lease, while the land component is operating lease.
ANSWER:
Fair Values Fraction Allocation For five years 1. Allocate the rental
Land 2M 2/5 403,126 2,015,630 2. If no fair value
Building 3M 3/5 604,689 3,023,445 and casnot be
Total 5M 1,007,815 5,039,075 allocated, whole
amount will be
1,007,815 x PVF of annuity due at 6% for 5 years
Annual lease payment = P __________ finance lease;
Annual lease payment = 4 4.465106
operating lease if
did not qualify
Journal Entry on January 1, 2024:
Account Names Debit Credit If Land is immaterial,
Land: Cash 403,126 building and land will
OPERATING Rent Income 403,126 be considered as one
LEASE item
Lease Receivable (604,689 x 5) 3,023,445
Building: Building @ CA 2,700,000
FINANCE Unearned Interest Income 323,445
LEASE

Finance Lease 56
LR ( ALP x LT)
Underlying Asset @ CA
UII (residual)
2) Both the lease of building and the lease of land are classified as finance lease.
ANSWER:
PV of lease payments = P ______________ x PVF of annuity due at 6% for 5 years
PV of lease payments =

Journal Entry on January 1, 2024:

Account Names Debit Credit
Lease Receivable 5,039,075
Land 1,800,000
Building 2,700,000
UII 539,075

3) Both the lease of building and the lease of land are classified as operating lease.
ANSWER:
Account Names Debit Credit
Cash 1,007,815
Rent Income 1,007,815

57
 PROBLEMS – ACCOUNTING FOR LESSOR
Direct Finance Lease Model

PROBLEM 26 (Computation of Unearned Interest Income – Revert to lessor at the end of lease term)
From the following independent assumptions, compute the unearned interest income related to direct finance lease.
Prepare the related journal entries.

At the beginning of year, the lessor leased its equipment to the lessee in which this leased asset will revert to the lessor
at the end of the 4-years lease term. The annual rental is payable at the end of each year with first payment on December
31 of year 1. Use six decimal places for present value factor, if applicable in the computation.

Annual Residual Value Cost of Initial Implicit

No. rental Guaranteed Unguaranteed Leased Asset Direct Cost Int. %
1 1,000,000 0 0 3,037,300 0 12% 3.037349
2 1,000,000 0 0 3,037,300 132,600 12% 3.037349
3 450,000 250,000 0 1,597,205 0 10% 3.169865

SOLUTION:
Situation 1:
Gross investment in the lease:
Gross rentals (Computation: ) 4,000,000
Residual Value (guaranteed or not guaranteed) 0 4,000,000
Less: Net investment in the lease:
Cost of the leased asset 3,037,300
Initial direct cost 0 3,037,300
Unearned Interest Income 962,700

Journal Entry:
Account Names Debit Credit
Lease Receivable) 4,000,000
Equipment 3,037,300
Unearned Interest Income* 962,300

*May also use Finance Lease Receivable

**May also use Discount on Finance Lease

Situation 2:
Gross investment in the lease:
Gross rentals (Computation: ) 4,000,000
Residual Value (guaranteed or not guaranteed) 0 4,000,000
Less: Net investment in the lease:
Cost of the leased asset 3,037,300
Initial direct cost 132,600 3,169,900
Unearned Interest Income 830,100

Journal Entry:
Account Names Debit Credit
Equipment 132,600
Cash 132,600

Lease Receivable 4,000,000

Equipment 3,169,900
Unearned Interest Income 830,100

58
Situation 3:
Gross investment in the lease:
Gross rentals (Computation: ) 1,800,000
Residual Value (guaranteed or not guaranteed) 250,000 2,050,000
Less: Net investment in the lease:
Cost of the leased asset 1,597,205
Initial direct cost 0 1,597,205
Unearned Interest Income 452,795

Journal Entry:
Account Names Debit Credit
Lease Receivable 2,050,000
Equipment 1,597,205
Unearned Interest Income 452,795

PROBLEM 27 (Computation of Unearned Interest Income – transfer to lessee at the end of lease term)
From the following independent assumptions, compute the unearned interest income related to direct finance lease.
Prepare the related journal entries.

At the beginning of year, the lessor leased its machinery to the lessee in which this leased asset will be transferred to the
lessor at the end of the given lease term in years (refer to the table below). The annual rental is payable at the end of
each year with first payment on December 31 of year 1. Use six decimal places for present value factor, if applicable in
the computation.

Annual Residual Value Cost of Initial Lease Implicit

No. rental Guaranteed Unguaranteed Leased Asset Direct Cost Term Int. %
1 1,600,000 1,000,000 0 6,064,000 0 5 10%
2 1,000,000 0 200,000 4,600,000 0 6 12%

SOLUTION:
Notes:
The residual value, whether guaranteed or not, is ignored because there is a transfer of title to the lessee at the end of
the lease term.

Situation 1:
Gross investment in the lease:
Gross rentals (Computation: ) 8,000,000
Less: Net investment in the lease:
Cost of the leased asset 6,064,000
Initial direct cost 0 6,064,000
Unearned Interest Income 1,936,000

Journal Entry:
Account Names Debit Credit
Lease Receivable 8,000,000
Equipment 6,064,000
Unearned Interest Income 1,936,000

59
Situation 2:
Gross investment in the lease:
Gross rentals (Computation: ) 8,000,000
Less: Net investment in the lease:
Cost of the leased asset 4,600,000
Initial direct cost 0 4,600,000
Unearned Interest Income 3,400,000

Journal Entry:
Account Names Debit Credit
Lease Receivable 8,000,000
Equipment 4,600,000
Unearned Interest Income 3,400,000

PROBLEM 28 (Various computations – Cost of leased asset is not given)

(Adapted from Chapter 10 - Illustration 6 from IA Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, Pepito Company leased out its equipment for four years under a finance lease. Annual lease payments
of P 700,000 are due at the beginning of each year starting on the current year.

Total residual value of the equipment at the end of the lease term is estimated to be P 500,000, P 300,000 of which is
guaranteed by the lessee. Implicit interest rate is 6%.

Required:
1. Using six decimal places for present value factor, determine the following assuming the equipment will revert back
to Pepito Company at the end of lease term:
a) The gross investment and net investment in the lease.
b) The Unearned finance income.

2. Assuming the same information except that the ownership of the equipment will be transferred to the lessee at the
end of lease term. Determine the following:
a) The gross investment and net investment in the lease.
b) The Unearned finance income.

SOLUTION:
1. Using six decimal places for present value factor, determine the following assuming the equipment will revert back
to Pepito Company at the end of lease term:
Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 2,800,000
Residual Value (guaranteed or not guaranteed) 500,000 3,300,000
Less: Net investment in the lease:
Cost of the leased asset
Annual rental x PV of annuity due
Computation: 2,571,108
Residual value x PV of 1
Computation: 396,047 2,967,155
Initial direct cost 0 2,967,155
Unearned Interest Income 332,845

Notes:
Since the underlying asset will be reverted to the lessor, therefore, the lessor will burden all the losses in residual
value. This is one reason why the unguaranteed residual value is also included in the computation of net investment
and gross investment.

60
 Journal Entry:
Journal Entry – January 1, 2023 Statement of Financial Position
Account Name Debit Credit As of January 1, 2023
Lease Receivable 3,300,000
Equipment 2,967,155 Asset:
Unearned Finance Income 332,845 Lease receivable 3,300,000
Less: Unearned Finance Income 332,845
Carrying amount/PV 2,967,155

2. Assuming the same information except that the ownership of the equipment will be transferred to the lessee at the
end of lease term.
Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 2,800,000
Less: Net investment in the lease:
Cost of the leased asset
Annual rental x PV of annuity due
Computation: 2,571,108
Initial direct cost 0 2,571,108
Unearned Interest Income 228,892

Notes:
Since the underlying asset will be transferred to the lessee at the end of the lease term, therefore, the lessee will
burden all the losses in residual value. This is one reason why both the guaranteed and the unguaranteed residual
values are excluded in the computation of net investment and gross investment.

Journal Entry – January 1, 2023 Statement of Financial Position

Account Name Debit Credit As of January 1, 2023
Lease Receivable 2,800,000
Equipment 2,571,108 Asset:
Unearned Finance Income 228,892 Lease receivable 2,800,000
Less: Unearned Finance Income 228,892
Carrying amount/PV 2,571,108

PROBLEM 29 (Two Situations Regarding Residual Value)

(Adapted from Chapter 10 - Illustration 7 from IA Vol. 2, 2023-2024 Edition by Vhinson Jay Garcia)
On January 1, 2023, South East Asian Bank financed Mabuhay Company’s purchase of a machinery for a total cost of P
7,151,206. The agreement provides that the annual lease payments are P 1,500,000 due at the beginning of each year
for the next five years equal to the useful life of the machinery. Residual value is P 800,000. Implicit interest rate is 7%.

Required (Use six decimal places for present value factors):

Using the following assumptions: (A) the residual value is guaranteed by the lessee; (B) the residual value is not
guaranteed by the lessee, determine the gross investment and net investment in the lease, and the unearned finance
income. Prepare the journal entry to record the transaction on lease commencement date.

SOLUTION:
Notes:
The problem is silent of the underlying asset will be revert to lessor or not. If the problem is silent, it is assumed that the
underlying asset will be reverted to the lessor at the end of the lease term.

61
1. Assumption (A) – The residual value is guaranteed by the lessee.
Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 7,500,000
Residual Value (guaranteed or not guaranteed) 800,000 8,300,000
Less: Net investment in the lease:
Cost of the leased asset 7,151,206
Initial direct cost 0 7,151,206
Unearned Interest Income 1,148,794

Journal Entry:
Account Names Debit Credit
Lease Receivable 8,300,000
Machinery 7,151,206
Unearned Interest Income 1,148,794

2. Assumption (B) – The residual value is NOT guaranteed by the lessee.

Answer:
The same answer as in number 1 despite the fact that the residual value is unguaranteed.

PROBLEM 30 (Computation of Annual Lease Rental – No transfer of ownership at the end of lease term)
For each of the following independent situations, compute the annual lease rental.

Assume that at the beginning of year, the lessor leased its equipment to the lessee in which this leased asset will revert
to the lessor at the end of the 4-years lease term. The annual rental is payable at the end of each year with first payment
on December 31 of year 1. Use six decimal places for present value factor, if applicable in the computation.

Annual Residual Value Cost of Initial Implicit

No. rental Guaranteed Unguaranteed Leased Asset Direct Cost Int. %
1 0 0 6,074,698 0 12%
2 0 0 6,074,698 265,200 12%
3 250,000 0 1,597,205 0 10%

SOLUTION:
Situation 1:
Annual rental = [Cost of leased asset - PV of residual value] / PV of OA 1
Annual rental =
Annual rental =

Situation 2:
Annual rental = [Cost of leased asset - PV of residual value] / PV of OA 1
Annual rental =
Annual rental =

Situation 3:
Annual rental = [Cost of leased asset - PV of residual value] / PV of OA 1
Annual rental =
Annual rental =
Annual rental =
Annual rental =

62
PROBLEM 31 (Computation of Annual Lease Rental – There is transfer of ownership at end of lease term)
For each of the following independent situations, compute the annual lease rental.

Assumed that at the beginning of year, the lessor leased its equipment to the lessee in which this leased asset will be
transferred to the lessee at the end of the given lease term in years (refer to the table below). The annual rental is
payable at the beginning of each year with first payment at the beginning of year 1. Use given present value factors for
present value factor that is applicable in the computation.

Case A: Title of ownership is to be returned to the lessor

Annual Residual Value Cost of Initial Lease Implicit PV of PV of
No. rental Guaranteed Unguaranteed Leased Asset Direct Cost Term Int. % 1 AD
1 0 200,000 2,300,000 0 6 yrs. 12% 0.51 4.60
2 0 0 1,700,900 66,300 4 yrs. 12% 0.6355 3.4018

SOLUTION:
Notes: The residual value is ignored because the title will be transferred to the lessee at the end of the lease term.
Situation 1:
Annual rental = Cost of leased asset / PV of annuity due
Annual rental =
Annual rental =
Situation 2:
Annual rental = Cost of leased asset / PV of annuity due
Annual rental =
Annual rental =

PROBLEM 32 (Revert to Lessor; payable every end of the year; no residual value)
(Adapted from Problem 13-1 from Intermediate Accounting Vol. 2, 2024 Edition by Valix, Peralta, Valix)
Rosal Company is in the business of leasing new sophisticated equipment. On January 1, 2024, an equipment was
delivered to a lessee under a direct financing lease.

The equipment shall revert to Rosal Company at the end of the lease.

Cost of equipment 2,600,000

Annual rental payable at the end of year 500,000
Initial direct cost paid by the lessor 225,000
Useful life and lease term 10 years
Implicit interest rate after initial direct cost 12%
Present value of an ordinary annuity of 1 at 12% for 10 years 5.650

Required: (modified)
1. Compute the unearned interest income on January 1, 2024.
2. Prepare the table of amortization from 2024 to 2026.
3. Prepare journal entries for 2024.
4. Present the lease receivable on the statement of financial position as of December 31, 2024 and 2025.

SOLUTION:
1. Computation of unearned interest income on January 1, 2024.
Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 5,000,000
Residual Value (guaranteed or not guaranteed) 0 5,000,000
Less: Net investment in the lease:
Cost of the leased asset 2,600,000
Initial direct cost 225,000 2,825,000
Unearned Interest Income 2,175,000
63
2. Table of Amortization:
Answer:
Lease Interest Net Investment
Year Date Payments Income Amortization C. Amount
(CA x __%) (CA – A)
0
1
2
3
4
5
6
7
8
9
10

3. Journal entries for 2024

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Initial direct cost payment. Equipment 225,000
Cash 225,000

Jan. 1 Initial measurement. Lease Receivable 5,000,000

Equipment 2,825,000
Unearned Interest Income 2,175,000

Dec. 31 Annual collection of lease Cash 500,000

payment Lease Receivable 500,000

Dec. 31 Interest income recognition Unearned Interest Income 339,000

Interest Income 339,000

4. Statement of Financial Position Presentation as of December 31, 2024 and 2025

Answer:
12/31/2024 12/31/2025
Current asset:
Lease Receivable 500,000 500,000
Less: Unearned Interest Income 319,680 298,042
Carrying amount 180,320 201,958

Noncurrent asset:
Lease Receivable 4,000,000 3,500,000
Less: Unearned Interest Income 1,516,320 1,218,278
Carrying amount 2,483,680 2,281,722

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PROBLEM 33 (Revert to Lessor; payable every end of the year; with residual value)
(Adapted from Problem 13-3 from Intermediate Accounting Vol. 2, 2024 Edition by Valix, Peralta, Valix)
Oceanic Company is engaged in leasing equipment. On January 1, 2024, such an equipment was delivered to a lessee
under a direct financing lease with the following provisions:

Cost of equipment to Camia 4,361,200

Unguaranteed residual value 200,000
Useful life and lease term 8 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 for 8 years at 10% 5.335
Present value of 1 for 8 years at 10% 0.466

The annual rental is payable at the end of each year. The equipment shall revert to the lessor upon the lease expiration.

Required (modified):
1. Determine the annual rental payable.
2. Compute the unearned rent income as of January 1, 2024.
3. Prepare the table of amortization.
4. Prepare journal entries for 2024.
5. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 180,000.
6. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 210,000.
7. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 180,000. It is further assumed that the residual value is guaranteed.
8. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 210,000. It is further assumed that the residual value is guaranteed.

SOLUTION:
1. Determine the annual rental payable.
Answer:
Annual rental = [Cost of leased asset – (PV of Residual value)] / PV of an OA of 1
Annual rental =
Annual rental =
Annua rental =
Annual rental =

2. Compute the unearned rent income as of January 1, 2024.

Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 8,000,000
Residual Value (guaranteed or not guaranteed) 200,000 8,200,000
Less: Net investment in the lease:
Cost of the leased asset 4,361,200
Initial direct cost 0 4,361,200
Unearned Interest Income 3,838,800

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3. Prepare the table of amortization.
Answer:
Lease Interest Net Investment
Year Date Payments Income Amortization C. Amount
(CA x __%) (CA – A)
0
1
2
3
4
5
6
7
8

4. Prepare journal entries for 2024.

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Initial measurement.

Dec. 31 Annual collection of lease

payment

Dec. 31 Interest income recognition

5. Prepare journal entry on January 1, 2031 tore cord the return of the equipment from the lessee The fair value of the
equipment on this date is P 180,000.
Answer:
Date Transactions Account Names Debit Credit
2031
Jan. 1 Return of the equipment by
the lessee.

6. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 210,000.
Answer:
Date Transactions Account Names Debit Credit
2031
Jan. 1 Return of the equipment by
the lessee.

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7. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 180,000. It is further assumed that the residual value is guaranteed.
Answer:
Date Transactions Account Names Debit Credit
2031
Jan. 1 Return of the equipment by
the lessee.

8. Prepare journal entry on January 1, 2031 to record the return of the equipment from the lessee. The fair value of
the equipment on this date is P 210,000. It is further assumed that the residual value is guaranteed.
Answer:
Date Transactions Account Names Debit Credit
2031
Jan. 1 Return of the equipment by
the lessee.

PROBLEM 34 (Revert to Lessor; payable every beginning of the year)

(Adapted from Problem 13-2 from Intermediate Accounting Vol. 2, 2024 Edition by Valix, Peralta, Valix)
Camia Company is in the business of leasing a ne sophisticated equipment. All leases are classified as direct financing.

At the end of the lease, the equipment shall revert to Camia Company. The implicit rate is 12% after considering the
initial direct cost.

On January 1, 2024, an equipment is leased to a lessee with the following information:

Cost of equipment to Camia 5,000,000

Residual value - guaranteed 600,000
Annual rental payable in advance 900,000
Initial direct cost paid by lessor 250,000
Useful life and lease term 8 years
Implicit interest rate 12%
First lease payment January 1, 2024

Required (modified):
1. Compute the unearned interest income on January 1, 2024.
2. Prepare a table of amortization for the lease receivable and interest income.
3. Prepare journal entries for 2024 and 2025.
4. Prepare journal entry on January 1, 2032 tore cord the return of the equipment from the lessee The fair value of the
equipment on this date is P 500,000.

SOLUTION:
1. Computation of unearned interest income on January 1, 2024.
Answer:
Gross investment in the lease:
Gross rentals (Computation: ) 7,200,000
Residual Value (guaranteed or not guaranteed) 600,000 7,800,000
Less: Net investment in the lease:
Cost of the leased asset 5,000,000
Initial direct cost 250,000 5,250,000
Unearned Interest Income 2,550,000

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2. Prepare a table of amortization for the lease receivable and interest income.
Answer:
Payment Lease Interest Net Investment
Year Date Payments Income Amortization C. Amount
(CA x __%) (CA – A)
0
1
2
3
4
5
6
7
8

ALTERNATIVE AMORTIZATION TABLE:

Payment Lease Interest Net Investment
Year Date Payments Income Amortization C. Amount
(CA x 12%) (CA – LP + II)
0 Jan. 1, 2024 5,250,000
1 Jan. 1, 2024 900,000 0 900,000 4,350,000
Dec. 31, 2024 522,000 522,000 4,872,000
2 Jan. 1, 2025 900,000 3,972,000
Dec. 31, 2025 476,640 476,640 4,448,640
3 Jan. 1, 2026 900,000 3,548,640
Dec. 31, 2026 425,837 425,837 3,974,477
4 Jan. 1, 2027 900,000 3,074,477
Dec. 31, 2027 368,937 368,937 3,443,414
5 Jan. 1, 2028 900,000 2,543,414
Dec. 31, 2028 305,210 305,210 2,848,624
6 Jan. 1, 2029 900,000 1,948,624
Dec. 31, 2029 233,835 233,835 2,182,459
7 Jan. 1, 2030 900,000 1,282,459
Dec. 31, 2030 217,541 217,541 1,500,000
8 Jan. 1, 2031 900,000 600,000

3. Journal entries for 2024 and 2025.

Answer:
Date Transactions Account Names Debit Credit
2024
Jan. 1 Initial direct cost payment. Equipment 250,000
Cash 250,000

Jan. 1 Initial measurement. Lease Receivable 7,800,000

Equipment 5,250,000
Unearned Interest Income 2,550,000

Jan. 1 First advance collection of Cash 900,000

lease payment Lease Receivable 900,000

Dec. 31 Interest income recognition Unearned Interest Income 522,000

Interest Income 522,000

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 Date Transactions Account Names Debit Credit
2025
Jan. 1 Second advance collection Cash 900,000
of lease payment Lease Receivable 900,000

Dec. 31 Interest income recognition Unearned Interest Income 476,640

Interest Income 476,640

4. Journal entry on January 1, 2032 to record the return of the equipment from the lessee. The fair value of the
equipment on this date is P 500,000.
Answer:
Date Transactions Account Names Debit Credit
2032
Dec. 31 Return of the equipment by Equipment 500,000
the lessor. Loss on Residual Value 100,000
Lease Receivable 600,000

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