Leases Part 2

Rate used in calculating present
value:
1. Interest rate implicit in the
lease
2. Lessee’s incremental
borrowing rate
Illustration: On January 1, 2020, an entity leased a
machinery for 4 years which is fixed is the same as the
useful life of the machinery at annual rental or fixed
payment of Php 100,000 payable at the end of each year.
The lease provides a transfer of ownership of the underlying

asset to the lessee at the end of the lease term.
The implicit interest rate is 12%.

Minimum Lease Payments (MLP) – payments over the lease
term that the lessee is or can be required to make,
excluding contingent rent, costs for services and taxes to be
paid and reimbursed to the lessor, together with:
1. For a lessee, any amounts guaranteed by the lessee or by
a party related to the lessee, or;
2. For a lessor, any residual value guaranteed to the lessor
by:
a. The lessee
b. A party related to the lessee; or
c. A third part unrelated to the lessor that is financially
capable of discharging the obligations under the guarantee.
Note: Guaranteed or unguaranteed
residual value is ignored in the
computation of minimum lease
payments when there is a transfer of
ownership or bargain purchase option
since the leased asset will not revert
back to the lessor.
Illustration:
On January 1, 2020, Abel Company leased a
building from Cain Company for a lease term of
10 years. The building has a useful life of 20
years. The rate implicit in the lease is 10%. Lease
payment of Php 400,000 is due ever December
31, starting December 31, 2020. The lease is
appropriately classified as finance lease. The
guaranteed residual value at the end of the lease
term is Php 100,000.
Case No.1: Assuming that the leased asset will be
transferred to the lessee at the end of the lease
term.
Case No. 2: Assume instead that the leased asset will
revert to the lessor at the end of the lease term and
the fair value of the leased asset is equal to the
present value of the minimum lease payments.
Required: For each of the above cases, determine the
following:
1. Total minimum lease payments
2. Present value of the minimum lease payments.
Illustration:
Finance Lease – Depreciation of Asset, BPO
and GRV
On December 31, 2020, Jericho Co. signed
a 4-year non-cancelable finance lease for a
new machine of Php 267,845. The machine
has a useful life of 10 years. Jericho
regularly uses straight-line depreciation on
similar asset.
CASE No. 1 – Assuming the cost of the
machine include Php 20,000 gross bargain
purchase option. At the end of the lease,
Jericho expects to exercise the bargain option.
Jericho estimates that the equipment’s fair
value will be Php 40,000 at the end of its
useful life.
CASE No. 2 – Assume instead that the cost of
machine includes Php 20,000 gross guaranteed
residual value.
Required: For each case above, compute for
the depreciation expense to be reported on
December 31, 2021.
Illustration: Certain Purchase Option
Lessee Company leased a machine on January 1, 2020 with the
following pertinent information:
Fixed rental payment at the end of each year….......Php 1,000,000
Lease term………………………………………………………………….....10 years
Useful life of machine……………………………………………………..12 years
Incremental borrowing rate…………………………………………..........14%
Implicit interest rate………………………………………………………………12%
PV of an ordinary annuity of 1 for 10 periods at
14% ------------------------------------------------------------------------5.216
12% ------------------------------------------------------------------------5.650
Present value of 1 for 10 periods at
14% ------------------------------------------------------------------------0.270
12% ------------------------------------------------------------------------0.322
Lessee Company has the option to purchase the
machine upon the lease expiration on January 1,
2030 by paying Php 500,000.
The lessee is reasonably certain to exercise the

purchase option at the commencement date of
the lease.
The estimated residual value of the machine at

the end of the 12-year life is Php 600,000.
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Illustration: Residual Value Guaranteed
Easy Company leased an equipment on January 1, 2020 with the
following information:
Fixed rental payment at the end of each lease year…Php 1,000,000
Lease term…………………………………………………………………...........4 years
Useful life of equipment………………………………………………………5 years
Implicit interest rate………………………………………………………………10%
PV of an ordinary annuity of 1 for 4 periods at 10%-----------3.16987
Present value of 1 for 4 periods at 10% -----------------------------0.683
Easy Company guaranteed a Php 200,000 residual value on

December 21,2023.
Illustration: Initial Direct Costs
On January 1, 2020, Simple Company leased an equipment with
the following information:
Annual fixed payment in advance at the beginning of each lease
year………………………………………………………………………….Php 1,000,000
Initial direct cost paid……………………………………………………….250,000
Lease Incentive Received………………………………………………….150,000
Residual Value Guarantee…………………………………………………300,000
Lease term: 5 years; Useful Life of Equipment: 6 years
Present value of an annuity of 1 in advance at 8% for 5
periods……………………………………………………………………..............4.3121
Present value of 1 at 8% for 5 periods………………………………….0.6806
Illustration: Unguaranteed Residual Value
Ezzy Company leased a warehouse on January 1, 2020 with the
following information:
Annual rental payable in at the end of each year…………Php 600,000
Unguaranteed Residual Value…….…….………………………………200,000
Payment to lessor to obtain long-term lease…………………….224,000
Cost of restoring asset as required by contract………………….634,920
Annual Executory Cost Paid………………………………………………..50,000
Lease term: 6 years; Useful Life of Equipment: 8 years
Implicit Int. Rate: 10%; Discount Rate for the Restoration Cost: 8%
Present value of an ordinary annuity of 1 at 10% for 6 periods..4.36
Present value of 1 at 10% for 6 periods…………………………………….0.56
Present value of 1 at 8% for 6 periods………………………………………0.63
ACTUAL PURCHASE OF UNDERLYING ASSET
Cost of Asset Purchased = Carrying Amount of the Leased
Asset + Cash Payment – Balance of the Leased Liability
Example: An entity purchased an equipment that it had
been leasing under a finance lease for Php 4,000,000. The
balances of certain accounts on the date of actual
purchase are:
Right of use asset ----------------------------------Php 5,000,000
Accumulated depreciation ----------------------------1,500,000
Lease Liability ---------------------------------------------3,800,000
References:
Intermediate Accounting 2 (2020 ed.)
Conrado T. Valix, Jose F. Peralta, Christian Aris M. Valix

Leases Part 2

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Leases Part 2

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Rate used in calculating present

The lease provides a transfer of ownership of the underlying

The implicit interest rate is 12%.

The lessee is reasonably certain to exercise the

The estimated residual value of the machine at

Easy Company guaranteed a Php 200,000 residual value on

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