Learning Resource 9: Lessor Accounting: Lesson 1: Operating Lease

Jerald Jay C.
Catacutan Intermediate Accounting

BSA-2B
Learning Resource 9: Lessor Accounting

Lesson 1:
OPERATING LEASE
A. Theoretical Exercises (Individual Task)
Choose the correct answer by writing the corresponding letter-answer and a convincing
justification that it is indeed the correct answer via applicable appropriate accounting
principles discussed in Activity 1.
1. Rent received in advance by the lessor in an operating lease should be recognized

as revenue
a. When received c. at the lease expiration
b. At the lease inception d. In the period specified by the lease
Answer: D
When the lessee pays advance in rental and security deposit, the lessee shall account
these as asset at the time of payment. These shall be reported as lease expense/ cost
in the period when applied to lease. On the part of the lessor, the advance/prepaid
rental and security deposit shall be recorded as liability in the period of receipt and shall
be reported as lease income in the period when applied to lease.
2. When should a lessor recognize in the income a non-refundable lease bonus paid by
a lessee?
a. When received c. At the lease expiration
b. At the inception of the lease d. Over the lease term
Answer: D
A non-refundable lease bonus should be recognized as a revenue over the lease term.
The receipt of the lease bonus creates deferred revenue.
3. Lease payments under an operating lease shall be recognized as an income by the

lessor on
a. Straight line basis over the lease term c. Sum of units basis
b. Diminishing balance basis d. Cash basis
Answer: A
IFRS 16 paragraph 81 provides that a lessor shall recognized lease payments from
operating lease as income either on a straight line basis. Straight line rent is the
concept that the total liability under a rental arrangement should be charged to
expense on an even periodic basis over the term of the contract.
4. In an operating lease that is recorded by the lessor, the equal monthly rental
payments should be
a. Recorded as reduction of depreciation.
b. Allocated between reduction in lease receivable and interest expense.
c. Recorded as reduction in the lease receivable.
d. Recorded as a rental income.
Answer: D
Under an operating lease, the lessor records rent revenue (credit) and a corresponding
debit or either cash or rent receivable. The asset remains on the lessor books as an
owned asset. The lessor record depreciation expense over the life of the asset.
5. Which statement characterizes an operating lease?

a. The lessee records depreciation and interest.
b. The lessee records a lease obligation.
c. The lessor transfers title of the underlying asset to the lessee for the duration of the
lease term.
d. The lessor records depreciation and lease revenue.
Answer: D
For operating leases, the lessors continues depreciating their asset being leased and
records the incoming lease receipts as revenue on a straight line method.
6. The classification of the lease is normally carried out

a. At the end of the lease term
b. After a “cooling off” period of one year
c. At the inception of the lease
d. When the entity deems it to be necessary
Answer: C
Inception of the lease means the date of the lease agreement or commitment, if
earlier, or the date the lease is purchased by the state bank. Inception of the lease
means the date of the lease agreement or commitment, if earlier, or the date the
lease is purchased by the credit union.
7. The classification of the lease as either operating or finance lease is based on

a. The length of the lease.
b. The transfer of the risk and rewards of ownership.
c. The lease payments being at least 50% of fair value.
d. The economic life of the underlying asset.
Answer: B
The current standards for revenue recognition under U.S GAAP states. ‘’ Revenue
can only be recognized if it is 1) realized or realizable 2) earned.’’ This risk rewards
approach stipulates that revenue to the company gets realized and earned
(recognized) when the risks and the rewards of ownership gets transferred to the
customer, and the seller no longer has control.
8. All the following situations would prima facie lead to a lease being classified as a
finance lease, except
a. Transfer of ownership to the lessee.
b. Option to purchase at a value below the fair value of the underlying asset.
c. The lease term is for a major part of the asset’s life.
d. The present value of the lease payments is 50% of the fair value of the asset
Answer: D
The lease term is only one half of the estimated economic life of the underlying asset,
the present value of the lease payment is only 50% of the fair value of the underlying
asset, and the asset is transferred back to the lessor at the end of the lease term.
9. In the case of lease of land and building, the lease payments should be split
a. According to relative fair value of the two elements.
b. Based on the useful life of the two elements.
c. Using the sum of digits method.
d. According to method devised by the entity.
Answer: A
Application Guidance B56 provides that a lease payments are allocated between the
land and building elements in proportion to the relative fair value of the leasehold
interest in the land and building elements at the inception of the lease.
10. Where there is lease of land and building and the title to the land is not transferred,
generally the lease is treated as if
a. The land is finance lease.
b. The land is finance and the building is operating.
c. The land is operating and the building is finance.
d. The land and building are on operating lease.
Answer: C
In determining whether the land element is an operating lease or a finance lease, an
important consideration is that land normally has an indefinite economic life. Leases
of land are assessed in the same way as all other leases. When a lease includes both
land and buildings elements, a lessor should assess the classification of each
element as a finance or an operating lease separately in accordance with IFRS 16:62
to 66.
11. The accounting concept that is principally used to classify leases into operating the
finance on the part of lessor is
a. Substance over form c. Neutrality b. Prudence d. Completeness
Answer: A
Substance over form is the concept that the financial statements and accompanying
disclosures of a business should reflect the underlying realities of accounting
transactions. The key point of the concept is that a transaction, which would mislead
the readers of a company’s financial statements.
12. Which statement is correct regarding the lease capitalization criteria?

a. The lease transfer ownership to the lessor.
b. The lease contains a purchase option.
c. The lease term is equal to at least 75% of the economic life of the underlying asset.
d. The lease payments are at least 90% of fair value of asset.
Answer: C
The lease term covers the major part of the underlying asset’s remaining economic
life. This is considered to be 75% or more of the remaining economic life underlying
asset. Under USA GAAP, major part means at least 75% of the economic life of an
asset.
13. Which condition would require lease capitalization?

a. The lease does not transfer title to the lessee.
b. There is an uncertain purchase option.
c. The present value of the lease payment is significantly more than the fair value of the
asset.
d. The lease term is below the useful life of asset.
Answer: C
The present value of the sum of all lease payments and any lessee guaranteed
residual value matches or exceeds the fair value of the underlying asset.
14. One of the four determinative criteria for a finance lease specifies that the lease
term be equal to or greater than
a. The economic life of the underlying asset.
b. 90 percent of the economic life of the asset.
c. 75 percent of the economic life of the asset.
d. 50 percent of the economic life of the asset.
Answer: C
If the lease period equals or exceeds 75 percent of the asset’s economic life, the
lessor transfers most of the risks and rewards ownership to the lessee.
15. One of the four determinative criteria for a finance lease is that the present value at
the beginning of the lease term of the lease payments equal or exceeds
a. The fair value of the underlying asset
b. 90 percent of the fair value of the underlying asset
c. 75 percent of the fair value of the underlying asset
d. 50 percent of the fair value of the underlying asset
Answer: B
Under USA GAAP substantially all means at least 90% of the fair value of the leased
asset. There is room for debate over whether substantially all implies a threshold
lower than or higher than 90%
II. Individual Task
Solve the following problems with solutions presented in good form; and choose the
correct answer (re: letter-answer) from the given probable answers.
1. ORSON Company
1.B
Solution:
2020 (100,000 x 12) P 1,200,000
2021 (150,000 x 12) 1,800,000
2022 (200,000 x 12) 2,400,000
2023 (250,000 x 12) 3,000,000
Total rent over the lease term P 8,400,000
Average annual rental (8,400,000/4) P 2,100,000
Rent income for 2020 and 2021 (2,100,000 x 2) P 4,200,000

Rent collected in 2020 and 2021 (1,200,000 + 1,800,000) (3,000,000)
Rent receivable- 12/31/2021 P 1,200,000
2. STAR Company
2. C
Solution:
Annual rental P 850,000
Amortization of lease bonus (300,000/3) 100,000
Total 950,000
Less: Depreciation P 400,000
Insurance 80,000 480,000
Operating profit P 470,000
3. BLUE Company
3.B
Solution:
Refundable security deposit P 50,000
4. RIBBON Company
4. A
Solution:
Rent income for Jan.1-June 30(60,000 x 6) P 360,000
Rent income for July 1-Dec.31 (75,000 x 6) 450,000
Total rent income 810,000
Less: Depreciation (4,800,000/8) 600,000
Net Rental Income- Dec.31,2021 P 210,000
5. MICKEY Company
5.A
Solution:
Pretax income (720,000 – 64,000 – 360,000) P 296,000

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Jerald Jay C.

Catacutan Intermediate Accounting

Learning Resource 9: Lessor Accounting

A. Theoretical Exercises (Individual Task)

1. Rent received in advance by the lessor in an operating lease should be recognized

3. Lease payments under an operating lease shall be recognized as an income by the

5. Which statement characterizes an operating lease?

6. The classification of the lease is normally carried out

7. The classification of the lease as either operating or finance lease is based on

12. Which statement is correct regarding the lease capitalization criteria?

13. Which condition would require lease capitalization?

Average annual rental (8,400,000/4) P 2,100,000

Rent income for 2020 and 2021 (2,100,000 x 2) P 4,200,000

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