Chapter 9

COMPOUND FINANCIAL INSTRUMENT

Problem 9-1 (AICPA Adapted)

At year-end, Fort Company issued 5,000 of 8%, 10-year, P1,000 face value bonds with detachable share
warrants at 110. Each bond carried a detachable warrant for ten ordinary shares of Fort Company at a
specified option price of P25 per share. The par value of the ordinary share is P20.

Immediately after issuance, the market value of the bonds without the warrants was P5,400,000 and the
market value of the warrants was P600,000.

What is the carrying amount of bonds payable at year-end?

a. 5,000,000
b. 4,950,000
c. 4,900,000
d. 5,400,000

Solution 9-1 Answer d

Issue price of bonds payable – equal to market value

without the warrants 5,400,000

The issue of bonds payable with share warrants is accounted for as a compound financial instrument.

Share warrants attached to a bond may be detachable and nondetachable.

Detachable warrants can be traded separately from the bond and nondetachable warrants cannot be
traded separately.

PAS 32, paragraph 28, mandates that the issuer of a compound financial instrument shall classify the
liability and equity component separately. This standard does not differentiate whether the equity
component is detachable or nondetachable.

Whether detachable or non detachable, the warrants have a value and therefore shall be accounted for
separately.

PAS 32, paragraph 31, further provides that equity instruments are instruments that evidence a residual
interest in the asset of the entity after deducting all of its liabilities.

Accordingly, the bonds are assigned an amount equal to “market value of the bonds ex-warrants ”
regardless of the market value of the warrants. The remainder of the issue price shall then be allocated
to the warrants.
Issue price of bonds with warrants (5,000,000 x 110) 5,500,000

Market value of bonds without warrants 5,400,000

Residual amount allocated to warrants – equity component 100,000

Actually, the entry to record the issue of the bonds payable with share warrants is as follows:

Cash 5,500,000

Bonds payable 5,000,000

Premium on Bonds payable 400,000

Share warrants outstanding 100,000

If all the share warrants are exercised by the bond holders, the journal entry is:

Cash ( 5,000 x 10 x P25) 1,250,000

Share warrants outstanding 100,000

Share capital ( 50 x 10 x P20) 1,000,000

Share premium 350,000

Problem 9-2 (AICPA Adapted)

On December 31, 2015, Moses Company issued P5,000,000 face value, 5-year bonds at 109. Each P1,000
bond was issued with 50 detachable share warrants, each of which entitled the bond holder to purchase
one ordinary share of P5 par value at P25. Immediately after issuance, the market value of each warrant
was P5.

The stated interest rate of the bonds is 11% payable annually every December 31. However, the
prevailing market rate of interest for similar bonds without warrants is 12%.

The present value of 1 t 12% for 5 periods is 0.57 and the present value of an ordinary annuity of 1 at
12% for 5 periods is 3.60.

On December 31, 2015, what amount should be recorded as discount or premium on bonds payable?

a. 170,000 discount
b. 450,000 premium
c. 450,000 discount
d. 800,000 discount
Solution 9-2 Answer a

PV of principal ( 5,000,000 X .57) 2,850,000

PV of annual interest payment ( 550,000 x 3.60) 1,980,000

Total present value of bonds payable 4,830,000

Bonds payable 5,000,000

Present value 4,830,000

Discount on bonds payable 170,000

If the market value of the bonds without warrants is unknown, the amount allocated to the bonds is
equal to the present value of the principal bond liability plus the present value of future interest
payment using the market rate of interest for similar bonds without the warrants.

Issue price of bonds with warrants ( 5,000,000 x 109%) 5,450,000

Present value of bonds payable 4,830,000

Residual amount allocated to warrants 620,000

Journal entry to record the issue bonds with share warrants

Cash 5,450,000

Discount on bonds payable 170,000

Bonds payable 5,000,000

Share warrants outstanding 620,000

Journal entry to record the exercise of all the share warrants

Cash ( 5,000 x 50 x P25) 6,250,000

Share warrants outstanding 620,000

Share capital (250,000 x P5) 1,250,000

Share premium 5,620,000

Problem 9-3 (AICPA Adapted)

On January 1, 2015, Case Company issued P5,000,000 of 12% nonconvertible bonds at 103 which are
due on February 28, 2020. In addition, each P1,000 bond was issued with 30 detachable share warrants,
each of which entitled the bond holder to purchase, for P50, one ordinary share of Case Company, par
value P25.

On January 1, 2015, the quoted market value of each warrant was P4. The market value of the bond ex-
warrants at the time of issuance is 95.

What amount of the proceeds from the bond issue should be recognized as an increase in shareholders’
equity?

a. 600,000
b. 300,000
c. 200,000
d. 400,000

Solution 9-3 Answer d

Issue price of bonds with warrants ( 5,000,000 x 103%) 5,150,000

Market value of bonds without warrants (5,000,000 x 95%) 4,750,000

Residual amount allocated to warrants-equity component 400,000

Problem 9-4 (IAA)

Moriones Company issued P5,000,000 face value 12% convertible bonds at 110 on January 1, 2015,
maturing on January 1, 2020 and paying interest semiannualy on January 1 and July 1. It is estimated
that would sell only at 103 without the conversion feature. Each P1,000 bond is convertible into 10
ordinary shares with P100 par value.

What is the increase in the shareholders’ equity arising from the issuance of the convertible bonds on
January 1, 2015?

a. 350,000
b. 500,000
c. 150,000
d. 0

Solution 9-4 Answer a

The issue of convertible bonds payable is also accounted for as a compound financial instrument.

Accordingly, PAS 32, paragraph 29, mandates that the original issuance of convertible bonds payable
shall be accounted for as partly liability and partly equity.
The liability component is equal to the market value of the bonds without the conversion privilege. The
equity component is the remainder or residual of the issue price of the bonds with conversion privilege.

Issue price of bonds with conversion privilege ( 5,000,000 x 110) 5,500,000

Market value of the bonds without conversion privilege ( 5,000,000 x 103) 5,150,000

Residual amount allocated to conversion privilege 350,000

Actually, the journal entry to record the issuance of the convertible bonds payable is:

Cash 5,500,000

Bonds payable 5,000,000

Premium bonds payable 150,000

Share premium-conversion privilege 350,000

Problem 9-5 (IAA)

Susan Company issued 5,000 convertible bonds on January 1, 2015. The bonds have a three-year term
and are issued at 110 with a face value of P1,000 per bond. Interest is payable annually in arrears at a
nominal 6% interest rate. Each bond is convertible at anytime up to maturity into 100 ordinary shares
with par value of P5.

When the bonds are issued, the prevailing market interest rate for similar debt instrument without
conversion option is 9%.

The present value of 1 at 9% for 3 periods is .77 and the present value of an ordinary annuity of 1 at 9%
for 3 periods is 2.53.

What is the equity component of the issuance of the convertible bonds on January 1, 2015?

a. 1,150,000
b. 1,650,000
c. 891,000
d. 391,000

Solution 9-5 Answer c

PV of principal ( 5,000,000 x .77) 3,850,000

PV of annual interest payments ( 300,000 x 2.53) 759,000

Total present value of bonds 4,609,000

Issue price of convertible bonds ( 5,000,000 x 110) 5,500,000

Present value of bonds 4,609,000

Equity component – Share premium 891,000

The liability component is equal to the market value of the bonds without conversion privilege.

If the market value of the bonds without the conversion privilege is unknown, the amount is equal to
the present value of principal bond liability plus the present value of the future interest payments using
the market rate of interest for similar bonds without the conversion privilege.

Problem 9-6 (AICPA Adapted)

Spare Company had outstanding share capital with par value of P50,000,000 and a 12% convertible
bond payable in the face amount of P10,000,000. Interest payment dates of bond issue are June 30 and
December 31.

The conversion clause in the bond indenture entitled the bond holders to receive 40 shares of P20 par
value in exchange for each P1,000 bond.

On June 30, 2015, the holders of P5,000 face value bonds exercised the conversion privilege. The market
price of the bonds on that date was P1,100 per bond and the market price of the share was P30.

The total unamortized bond discount at that date of conversion was P500,000. The share premium from
conversion privilege has a balance of P2,000,000 on June 30, 2015.

What amount of share premium should be recognized by reason of the conversion of bonds payable into
share capital?

a. 2,000,000
b. 2,750,000
c. 3,000,000
d. 1,750,000

Solution 9-6 Answer d

Bonds payable 10,000,000

Discount on bonds payable ( 500,000)

Carrying amount 9,500,000

Carrying amount converted (5/10 x 9,500,000) 4,750,000

Applicable share premium from conversion privilege

( 5/10 x 2,000,000) 1,000,000

Total consideration 5,750,000

Par value of shares issued ( 5,000 x 40= 200,000 shares x 20) 4,000,000

Share premium from conversion 1,750,000

Problem 9-7 (IFRS)

On December 31, 2015, Green Company issued 2,000 convertible bonds with a nominal interest rate
of 7% at P2,000 each. Each bond can be converted into 5 new equity shares or redeemed for cash,
at the option of the holder, in 5 years’ time. The fair value of the date of similar bonds without the
convertibility option was estimated at P1,500 each.

What is the amount recognized in equity in respect of the issuance of convertible bonds on
December 31, 2015?

a. 4,000,000
b. 3,000,000
c. 1,000,000
d. 0

Solution 9-7 Answer c

Issue price (2,000 x P2,000) 4,000,000

Fair value of bonds without option ( 2,000 x P1,500) 3,000,000

Equity component 1,000,000

Problem 9-8 (AICPA Adapted)

Clay Company had P600,000 convertible 8% bonds payable outstanding on June 30, 2015. Each
P1,000 bond was convertible into 10 ordinary shares of P50 par value.

On July 1, 2015, the interest was paid to bondholders and the bonds were converted into ordinary
shares, which had a fair value of P75 per share.
The unamortized premium on these bonds was P12,000 at the date of conversion. No equity
component was recognized when the bonds were originally issued.

What is the increase in the share capital and share premium respectively, as a result of the bond
conversion?

a. 300,000 and 312,000

b. 306,000 and 306,000
c. 450,000 and 162,000
d. 600,000 and 12,000

Solution 9-8 Answer a

Bonds payable 600,000

Premium on bonds payable 12,000

Carrying amount 612,000

Ordinary share issued at par value ( 6,000 x 50) 300,000

Share premium 312,000

Problem 9-9 (AICPA Adapted)

On December 31, 2015, Cey Company had outstanding 10%. P1,000,000 face amount convertible
bond payable maturing on December 31, 2018. Interest is payable on June 30 and December 31.
Each P1,000 bond is convertible into 50 shares of P10 par value. On December 31, 2015, the
unamortized premium on bonds payable was P60,000.

On December 31, 2015, 400 bonds were converted when Cey’s share had a market price of P24. The
entity incurred P4,000 in connection with the conversion. No equity component was recognized
when the bonds were originally issued.

What is the share premium from the issuance of shares as a result of the bond conversion on
December 31, 2015?

a. 176,000
b. 220,000
c. 276,000
d. 280,000
Solution 9-9 Answer b

Bonds payable 1,000,000

Premium on bonds payable 60,000

Carrying amount 1,060,000

Carrying amount converted ( 400/1,000 x 1,060,000) 424,000

Par value of shares issued ( 400 x 50 x P10) 200,000

Share premium 224,000

Conversion expenses ( 4,000)

Net share premium 220,000

Problem 9-10 (IAA)

Young Company issued 5,000 convertible bonds at the beginning of the current year. The bonds had
a four-year term with a stated rate of interest of 6% and were issued at par with a face value of
P1,000 per bond. Interest is payable annually on December 31.

Each bond is convertible into 50 ordinary shares with a par value of P10. The market rate of interest
on similar nonconvertible bonds is 9%.

At the issuance date, the amount of P485,000 was credited to share premium for conversion
privilege.

The bonds were not converted and instead, the entity paid of the convertible bondholders as
maturity.

What amount should be recorded as gain or loss on the full payment of the convertible bonds at
maturity?

a. 2,500,000 gain
b. 485,000 loss
c. 485,00 gain
d. 0
Solution 9-10 Answer d

To record the issuance of convertible bonds:

Cash 5,000,000

Discount on bonds payable 485,000

Bonds payable 5,000,000

Share premium-conversion privilege 485,000

To record the settlement of the convertible bonds at maturity date:

Bonds payable 5,000,000

Interest expense ( 6% x 5,000,000) 300,000

Cash 5,300,000

Share premium-conversion privilege 485,000

Share premium-issuance 485,000

Problem 9-11 (IAA)

On January 1, 2015, Arlene Company issued convertible bonds with a face value of P5,000,000 for
P6,000,000. The bonds are convertible into 50,000 shares with P100 par value. The bonds have a 5-
year life with 10% stated interest payable annually every December 31. The fair value of the
convertible bonds without conversion option is computed at P5,399,300 on January 1, 2015.

On December 31, 2017, the convertible bonds were not converted but fully paid for P5,500,000. On
such date, the fair value of the bonds without conversion privilege is P5,400,000 and the carrying
amount is P5,178,300.

What is the loss of the extinguishment of the convertible bonds on December 31, 2017?

a. 221,700
b. 371,700
c. 150,000
d. 0
 Solution 9-11 Answer a

Issue price 6,000,000

Fair value of the bonds without conversion option 5,399,300

Share premium-conversion privilege 600,700

Total payment – December 31, 2017 5,550,000

Payment applicable to bonds payable (5,400,000)

Equity component 150,000

Carrying amount on bonds payable 5,178,300

Payment applicable to bonds payable (5,400.000)

Loss on extinguishment ( 271,000)

Journal entries on December 31,2017

Bonds payable 5,000,000

Premium on bonds payable 178,300

Share premium-conversion privilege 150,000

Loss on extinguishment 221,700

Cash 550,000

Interest expense ( 10% x 5,000,000) 500,000

Cash 500,000

Share premium-conversion privilege 450,700

Share premium-issuance ( 600,700 – 150,000) 450,700

Problem 9-12 (AICPA Adapted)

At year-end, Guadalupe Company issued 6,000 of 9%, 10-year, P1,000 face value bonds with detachable
share warrants at 110. Each bond carried a detachable warrant for ten ordinary shares of Fort Company
at a specified option price of P25 per share. The par value of the ordinary share is P20.
Immediately after issuance, the market value of the bonds without the warrants was P6,400,000 and the
market value of the warrants was P500,000.

What is the carrying amount of bonds payable at year-end?

a. 5,000,000
b. 5,950,000
c. 4,600,000
d. 6,400,000

Solution 9-12 Answer d

Issue price of bonds payable – equal to market value

without the warrants 6,400,000

Problem 9-13 (IAA)

Gutierrez Company issued P5,000,000 face value 12% convertible bonds at 120 on January 1, 2015,
maturing on January 1, 2020 and paying interest semiannualy on January 1 and July 1. It is estimated
that would sell only at 103 without the conversion feature. Each P1,000 bond is convertible into 10
ordinary shares with P100 par value.

What is the increase in the shareholders’ equity arising from the issuance of the convertible bonds on
January 1, 2015?

a. 850,000
b. 500,000
c. 150,000
d. 0

Solution 9-13 Answer a

The issue of convertible bonds payable is also accounted for as a compound financial instrument.

Accordingly, PAS 32, paragraph 29, mandates that the original issuance of convertible bonds payable
shall be accounted for as partly liability and partly equity.

The liability component is equal to the market value of the bonds without the conversion privilege. The
equity component is the remainder or residual of the issue price of the bonds with conversion privilege.

Issue price of bonds with conversion privilege ( 5,000,000 x 120) 6,000,000

Market value of the bonds without conversion privilege ( 5,000,000 x 103) 5,150,000
Residual amount allocated to conversion privilege 850,000

Actually, the journal entry to record the issuance of the convertible bonds payable is:

Cash 6,000,000

Bonds payable 5,000,000

Premium bonds payable 150,000

Share premium-conversion privilege 850,000

Problem 9-14 (AICPA Adapted)

On January 1, 2015, Case Company issued P5,000,000 of 12% nonconvertible bonds at 106 which are
due on February 28, 2020. In addition, each P1,000 bond was issued with 30 detachable share warrants,
each of which entitled the bond holder to purchase, for P50, one ordinary share of Case Company, par
value P25.

On January 1, 2015, the quoted market value of each warrant was P4. The market value of the bond ex-
warrants at the time of issuance is 97.

What amount of the proceeds from the bond issue should be recognized as an increase in shareholders’
equity?

a. 600,000
b. 300,000
c. 400,000
d. 450,000

Solution 9-14 Answer d

Issue price of bonds with warrants ( 5,000,000 x 106%) 5,300,000

Market value of bonds without warrants (5,000,000 x 95%) 4,850,000

Residual amount allocated to warrants-equity component 450,000

Problem 9-15 (IFRS)

On December 31, 2015, Green Company issued 3,000 convertible bonds with a nominal interest rate
of 7% at P3,000 each. Each bond can be converted into 5 new equity shares or redeemed for cash,
at the option of the holder, in 5 years’ time. The fair value of the date of similar bonds without the
convertibility option was estimated at P1,500 each.

What is the amount recognized in equity in respect of the issuance of convertible bonds on
December 31, 2015?

A. 4,500,000
B. 3,000,000
C. 1,000,000
D. 0

Solution 9-15 Answer a

Issue price (3,000 x P3,000) 9,000,000

Fair value of bonds without option ( 3,000 x P1,500) ( 4,500,000)

Equity component 4,500,000

 Chapter 10

OPERATING LEASE

Problem 1-1 (AICPA Adapted)

On July 1, 2015, Kemp Company leased office space for five years at P150,000 a month. On that date
the entity paid the lessor the following amounts:

Rent security deposit 350,000

First month’s rent 150,000

Last month’s rent 150,000

Nonrefundable reimbursement to lessor for

modification to the lease premises 900,000

1,550,000

The entity made timely rental payments from August 1 through December 1, 2015.

What portion of payments to the lessor should be deferred on December 31, 2015?

a. 1,400,000
b. 1,310,000
c. 1,250,000
d. 500,000

Solution 10-1 Answer b

Leasehold improvement 900,000

Less: depreciation from July 1 to December 31, 2015

( 900,000/5 x 6/12 ) 90,000

Leasehold improvement, December 31, 2015 810,000

Rent security deposit 350,000

Last month’s rent 150,000

Total amount to be deferred 1,310,000

Problem 10-2 (AICPA Adapted)

On January 1, 2015, Park Company signed a 10-year operating lease for office space at P960,00 per year.
The lease included a provision for additional rent of 5% of annual company sale in excess of P5,000,000.
The sales for the year ended December 31, 2015 totaled P6,000,000. Upon execution of the lease , the
entity paid P240,000 as a bonus for the lease.

What is the rent expense for the year ended December 31, 2015?

a. 984,000
b. 1,010,000
c. 1,034,000
d. 1,250,000

Solution 10-2 Answer c

Annual rent 960,000

Additional rent ( 5% x 1,000,000) 50,000

Amortization of bonus ( 240,000/10) 24,000

Total rent expense 1,034,000

Problem 10-3 (AICPA Adapted)

Kew Company leases and operates a retail store. The following information relates to the lease for the
current year:

• The store lease, an operating lease, calls for a base monthly rent of P15,000 on the first day of
each month.
• Additional rent is computed at 6% of net sales over P3,000,000 up to P6,000,000 and 5% of net
sales over P6,000,000, per calendar year.
• Net sales for the current year amounted to P9,000,000.
• The entity paid executor cost to the lessor for property taxes of P120,000 and insurance of
P50,000.

What total amount of the expenses should be reported for the year?

a. 710,000
b. 680,000
c. 540,000
d. 350,000
Solution 10-3 Answer b

Annual rent ( 15,000 x 12 ) 180,000

Additional rent

6% x 3,000,000 180,000

5% x 3,000,000 150,000

Property taxes 120,000

Insurance 50,000

Total expenses 680,000

Problem 10-4 (AICPA Adapted)

As an inducement to enter a lease, Aris Company, a lessorr, granted Hompson Company, a lessee, nine
months of free rent under a five year operating lease. The lease was effective on July, 2015 and
provided for monthly rental of P100,000 to begin April 1, 2016.

In the income statement for the year ended June 30,2016, what amount should be recorded as rent
expense?

a. 1,020,000
b. 900,000
c. 300,000
d. 255,000

Solution 10-4 Answer a

Total rent expense ( 100,000 x 51 remaining months) 5,100,000

Average annual rent expense, July 1, 2015 to June 30, 2016 ( 5,100,000/5) 1,020,000

Paragraph 33 and 50 of PAS 17 provide that the total rentals in an operating lease shall be recognized by
the lessor and lessee uniformly at a straight line basis over the lease term unless another systematic
basis is representative of the time pattern of the user’s benefit.
Problem 10-5 (IFRS)

Jana Company leased a building for 20 years with effect from January 1, 2015. The useful life the
building is 40 years. As part of the negotiations for the lease, the lessor granted Jana a rent-free period.
Annual rental of P1600,000 are payable in advance in January 1, commencing in 2017.

What amount of rent expense should be recognized for the year ended December 31,2015?

a. 1,600,000
b. 1,520,000
c. 1,440,000
d. 0

Solution 10-5 Answer c

Total rental ( 1,600,000 x 18 years) 28,800,000

Average annual rental ( 28,800,000/20 years) 1,440,000

Problem 10-6 (AICPA Adapted)

On October 1, 2015, Dean Company leased office space at a monthly rental of P300,000 for 10 years
expiring September 30, 2025. As an inducement for Dean to enter into the leased, the lessor permitted
Dean to occupy the premises rent-frree from October 1 to December 31, 2015.

For the year ended December 31,2015, what amount should be reported as rent expense?

a. 900,000
b. 292,500
c. 877,500
d. 0

Solution 10-6 Answer c

Total rent expense ( P300,000 x 117 remaining months) 35,100,000

Average annual rent (35,100,000/10) 3,510,000

Rent expense from October 1 to December 31, 2015

(3,510,000 x 3/12) 877,500

Problem 10-7 ( PHILCPA Adapted)

On July,2015,Walton Company lease office premises for a three-year period at annual of P360,000
payable on July 1 each year. The first rent payment was made July 1,2015. Additionally on July 1, 2015,
the entity paid P240,000 as a lease instead of the lessor usual terms of six years.

On December 31,2015, what amount should reported as prepaid rent?

a. 180,000
b. 220,000
c. 240,000
d. 380,000

Solution 10-7 Answer d

Rent payment on July1,2015, (3,600,000 x 6/12) 180,000

Lease bonus ( 240,000 x 30/36) 200,000

Prepaid rent-December 31, 2015 380,000

Problem 10-8 (IFRS)

As an incentive to open a four-year operating lease for a warehouse, Dunhill Company receive an
upfront cash of P60,000 upon signing an agreement at the beginning of current year. The annual
rental is P1,115,000.

What amount should be recognized as lease expense for the current year?

a. 1.115,000
b. 1,100,000
c. 1,055,000
d. 0

Solution 10-8 Answer b

Annual rental 1,115,000

Amortization of upfront cash received (60,000/400) ( 15,000)

Lease expense for the current year 1,100,000

Problem 10-9 (IFRS)

As an incentive to enter a noncancelable operating lease for office premises for 10 years, Valley
Company as lessor has offered the lessee a rent-free period of two years. Annual rental payment
under the lease commencing in the third year is P500,000.

What amount of lease income should be recognized by Valley Company in the first year?

a. 400,000
b. 500,000
c. 450,000
d. 0

Solution 10-9 Answer a

Total rental ( 500,000 x 8 years ) 4,000,000

Average annual rental ( 4,000,000/10) 400,000

Problem 10-10 (AICPA Adapted)

Wall Company leased office premises to Fox Company for a five-year term beginning January 1,
2015. Under the terms of the operating lease, rent for the first year is P800,000 and rent for years 2
through 5 is P1,250,000 per annum. However, an inducement to enter the lease, Wall granted Fox
the first six month of the lease rent-free.

What amount should Wall report as rental income for 2015?

a. 1,200,000
b. 1,160,000
c. 1,080,000
d. 800,000

Solution 10-10 Answer c

First year ( 800,000 x 6/12) 400,000

Second year 1,250,000

Third year 1,250,000

Fourth year 1,250,000

Fifth year 1,250,000

Total rental revenue 5,400,000

Average annual rental revenue ( 5,400,000/5) 1,080,000

Problem 10-11 (AICPA Adapted)

Conn Company owns an office building and normally charges tenants P3,000 per square meter per
year for office space. Because the occupancy rate is low, Conn agreed to lease 100 square meters to
Hanson Company at P1,200 per square meter for the first year of a three year operating lease. Rent
for remaining years will be at the P3,000 rate. Hanson moved into the building on January 1, 2015,
and paid the first years rent in advance.

What amount of rental revenue should Conn record fro Hanson in the income statement for the
year ended September 30, 2015?

a. 90,000
b. 120,000
c. 180,000
d. 240,000

Solution 10-11 Answer c

First year (1,200 X 100) 120,000

Second year (3,000 x 100) 300,000

Third year (3,000 x 100) 300,000

Total rental revenue 720,000

Average annual rental ( 720,000/3) 240,000

Rental revenue from January 1 to September 30,2015

(240,000 x 9/12) 180,000

Problem 10-12 (AICPA Adapted)

Rapp Company leased a new machine to Lake Company on January 1,2015. The lease expires on
January 1, 2020. The annual rental is P900,000. Additionally, on January 1, 205, Lake paid P500,000
to Rapp as lease bonus and P250,000 as a security deposit to be refunded upon expiration of the
lease.

What amount of rental revenue should be reported for 2015?

a. 1,400,000
b. 1,250,000
c. 1,000,000
d. 900,000
Solution 10-12 Answer c

Annual rental 900,000

Amortization of lease bonus (500,000/5) 100,000

Total rental revenue 1,000,000

The lease bonus received by the lessor is accounted for as unearned rent income to be amortuized
over the lease term

The security deposit is noncurrent liability of the lessor.

Problem 10-13 (AICPA Adapted)

Jade Company purchased a new machine for P4,800,000 on January 1, 2015 and leased it to East the
same day. The machine has an estimated 12-year life and will be depreciated P400,000 per year. The
lease is for a three year period expiring January 1,2018, at an annual rental of P850,000.
Additionally, East paid P300,000 to Jade as a lease bonus to obtain the three year lease. Jade
incurred insurance expense of P80,000 for the leased machine during 2015.

What is the operating profit on the leased asset for 2015?

a. 670,000
b. 550,000
c. 470,000
d. 370.000

Solution 10-13 Answer c

Annual rental 850,000

Amortization of leased bonus ( 300,000/3 ) 100,000

Total 950,000

Less: Depreciation 400,000

Insurance 80,000 480,000

Operating profit 470,000

Problem 10 -14 (IAA)

 Hutch Company leased equipment to elder company on July 1, 2015 for one year period expiring
June 30, 2016 for P60,000 a month. On July 1, 2016, Hutched leased this piece of equipment to Toil
Company for a three year period expiring June 30, 2019 for P75,000 a month. The original cost of
the equipment was P4,800,000. The equipment which has been continually on lease since July 1,
2011 is being depreciated on a straight line basis over an eight year period with no residual value.
Both the lease to Elder and the lease Toil are appropriately recorded as operating lease.

What is the amount of net rental income that would be reported by Hutch Company for the year
ended December 31, 2016?

a. 210,000
b. 450,000
c. 810,000
d. 360,000

Solution 10-14 Answer a

Rent income-elder (60,000 x 6) 360,000

Rent income-toil (75,000 x 6) 450,000

Total rent income for 2016 810,000

Depreciation (4,800,000/8) (600,000)

Net rental income for 2016 210,000

Problem 10-15 (AICPA Adapted)

Barnel Company owns and manages apartment complex. On signing a lease, each tenant must pay
the first and last month’s rent and a P50,000 refundable security deposit. The security deposits are
rarely refunded in total, because cleaning costs of P15,000 per apartment are almost always
deducted. About 30% of the time, the tenants are also charged for damages to the apartment which
typically cost P10,000 to repair.

If a one year lease is signed on a P90,000 per month apartment, what amount should reported as
refundable security deposit?

a. 140,000
b. 50,000
c. 35,000
d. 32,000

Solution 10-23 Answer b

Refundable security deposit 50,000