CHAPTER 10: LESSE ACCOUNTING and depreciated over the shorter between the lease term and the

over the shorter between the lease term and the life of
the improvements.)

*Any security deposit refundable upon the lease expiration is accounted

LEASE – A contract or part of a contract that conveys the right to use for as an asset by the lessee.
the underlying asset for a period in exchange for consideration.

RIGHT TO CONTROL THE USE OF AN ASSET

Lessee shall depreciate the right of use asset over the useful life of the
a. Obtain substantially all of the economic benefits from the use underlying asset under the following conditions:
of the identified asset.
 Having the exclusive use of the asset throughout the period. a. The lease transfers ownership of the underlying asset to the
b. Direct use if the identified asset. lessee at the end of the lease term.
 How and for what purpose the asset is used throughout the b. The lessee is reasonably certain to exercise a purchase
period. option.

*If none of the conditions were met, the lessee shall depreciate the right
*A LESSEE shall recognize a right of use asset and a lease liability. of use asset over the shorter between the useful life of the asset and the
lease term.
*ALL LEASES shall be accounted for by the lessee as a finance lease
under the new lease standard. MEASUREMENT OF LEASE LIABILITY

UNDERLYING ASSET – The subject of a lease for which the right to  At the commencement date, shall measure the liability at the
use that asset has been provided by the lessor to the lessee. PV of lease payments.
 Discounted using implicit interest rate, if not determined, the
LESSEE – Entity that obtains the right to use an underlying asset for a incremental borrowing rate is used.
period in exchange for consideration.  The implicit interest rate caused the PV of lease payments
and the unguaranteed residual value to equal the fair value of
LESSOR – Entity that provides the right to use an underlying asset for
the underlying asset and initial direct cost of the lessor.
period in exchange for consideration.
FIXED PAYMENTS – Payments made by the lessee to the lessor during
*Under the OPERATING LEASE MODEL, the periodic rental is simply the lease term.
recognized as rent expense on the part of the lessee.
VARIABLE PAYMENTS – Payments made by the lessee that vary
SHORT-TERM LEASE – A lease with a term of 12 months or less at the
because of the changes in facts or circumstances occurring after the
commencement date of the lease.
commencement date other than passage of time.
*A lease that contains a purchase option is not short-term RISIDUAL VALUE GUARANTEE – Guarantee made to the lessor by a
CLASS OF UNDERLYING ASSET – grouping underlying assets of party unrelated to the lessor that the value of an underlying asset at the
similar nature and use in an entity’s operations. end if the lease term would be at least a specified amount.

LOW VALUE ASSET – Matter of professional judgment. UNGUARANTEED RESIDUAL VALUE – Portion of the residual value
of the underlying asset, the realization of which by the lessor is not
*A lessee shall assess the value of an underlying asset based on the assured or is guaranteed solely by a party related to the lessor.
value of the asset when it is new regardless of the age of the asset being
EXECUTORY COST – Ownership expenses such as maintenance,
used.
taxes and insurance for the underlying asset.
FINANCE LEASE – Transfers substantially all of the risk and rewards
incidental to ownership of an underlying asset. *Expensed immediately when incurred.

LEASE TERM – Non-cancelable period.

*At the commencement date, the lessee shall recognize a right to use
asset and lease liability. Illustration – Transfer of title to lease

On January 01, 2021, an entity leased a machinery for 4 years which is

INITIAL MEASUREMENT OF RIGHT OF USE ASSET the same as the useful life of the machinery at annual rental or fixed
payment of P100,000 payable at the end of each year.
a. The PV of lease payments or the initial measurement of lease
liability. The lease provides for a transfer of ownership of the underlying asset to
b. Lease payments made to lessor at or before commencement the lessee at the end of the lease term.
date, such as bonus, less any lease incentives received.
Implicit Int % = 12%
c. Initial direct cost incurred by the lessee.
d. Estimate the cost of dismantling, removing and restoring the PV of ordinary annuity = 3.0373
underlying asset for which the lessee has a present obligation.
 Must be required by contract or law 100,000 x 3.0373 = 303,730
LEASE INCENTIVES – Payments by the lessor to the lessee associated Right of use asset 303,730
with a lease or the reimbursement or assumption by the lessor of the
cost of the lessee. Lease liab 303,730

 Should be deducted from the cost of the right of use asset. Depreciation = PV – residual value/useful life or lease term whichever is
shorter if the conditions aren’t met
INITIAL DIRECT COST – Incremental cost of obtaining a lease that
would not have been incurred if the lease had not been obtained. 303,730/4 years = 75,932

 Added when computing cost of right of use asset Depreciation 75,932

*Leasehold Improvements are not initial direct cost and not included Accum. Dep. 75,932
in the cost of the right of use asset. (Separately accounted for as PPE
 Date Payment Interest Principal PV
01/01/21 100,000 303,730
12/31/21 100,000 36.448 63,552 240,178 Journal entries
12/31/22 100,000 28,821 71,179 168,999
1/1/21
12/31/23 100,000 20,280 79,720 89,279
12/31/24 100,000 10,721 89,279 - Right of use asset 5,811,000
303,730 x 12% = 36, 448
Lease liab 5,811,000
100,000 – 36,448 = 63,552
12/31/21
303,730 – 63,552 = 240,178
Interest exp 697,320
Journal Entry
Lease liab 302,680
12/31/21
Cash 1,000,000
Interest Exp. 36,448
5,811-600 = 5,211/12 = 434,250
Lease Liab. 63,552
Depreciation 434,250
Cash 100,000
Accumulated dep 434,250
12/31/22
Exercise of purchase option
Interest Exp. 28,821
Lease liab 500,000
Lease Liab. 71,179
Cash 500,000
Cash 100,000
Non-exercise of purchase option
*If the FS is prepared on December 31, 2021 the right of use of asset
would be reported as a separate line item under noncurrent asset 434,250 x 10years

Right of use asset 303,730 Accumulated dep 4,342,500

Acc. Depreciation (75,932) Lease liab 500,000

Carrying Amount 227,798 Loss on finance 968,500

Illustration – Certain purchase option Right of use asset 5,811,000

On January 01, 2021 Lessee Company leased a machine Illustration – Residual value guarantee

Fixed rental payment 1,000,000 On January 1, 2021, Easy Company leased an equipment

Lease term 10 years Fixed annual payment 1,000,000

Useful life 12 years Lease term 4 years

Incremental borrowing % 14% Useful life 5 years

Implicit interest % 12% PV of 1 at 10% 0.683

Lessee Company had the option to purchase the machine upon the PV of ordinary annuity at 10% 3.170
lease expiration on January 01, 2031 by paying P500,000.
Easy Company guaranteed a P200,000 residual value on December 31,
The estimated residual value of the machine at the end of the 12-year 2024 to the lessor.
useful life is P600,000
PV of lease payments (1M x 3.170) 3,170,000
PV of 1 for 10p 14% = 0.270 | 12% = 0.322
PV of residual value (200k x .683) 136.600
PV of ordinary annuity 14% = 5.216 | 12% = 5.650
Total liab 3,306,600
PV of lease payments (1M x 5.65) 5,650,000
Depreciation = 3,306,600 – 200,000 = 3,106,600/4 years = 776,650
PV of purchase option (500K x .322) 161,000
Date Payment Interest Principal PV
Total lease liab 5,811,000
1/1/2021 3,306,600
Date Payment Interest Principal PV
01/01/21 5,811,000 12/31/2021 1,000,000 330,660 669,340 2,637,260
12/31/21 1,000,000 697,320 302,680 5,508,320 12/31/2022 1,000,000 263,726 736,274 1,900,986
12/31/22 1,000,000 660,998 339,002 5,169,318
12/31/2023 1,000,000 190,099 809,901 1,091,085
12/31/23 1,000,000 620,318 379,682 4,789,637
12/31/24 1,000,000 574,756 425,244 4,364,393 12/31/2024 1,000,000 108,915 891,085 200,000
12/31/25 1,000,000 523,727 476,273 3,888,120
12/31/26 1,000,000 466,574 533,426 3,354,695
12/31/27 1,000,000 402,563 597,437 2,757,258
12/31/28 1,000,000 330,871 669,129 2,088,129
12/31/29 1,000,000 250,575 749,425 1,338,704
12/31/30 1,000,000 161,296 838,704 500,000
Journal Entries Depreciation 4,616,280 – 300,000 = 4,316,280/5 = 863,256

1/1/21 Date Payment Interest Principal PV

Right of use asset 3,306,600 1/1/2021 4,516,280
1/1/2021 1,000,000 - 1,000,000 3,516,280
Lease liab 3,306,600
1/1/2022 1,000,000 281,302 718,698 2,797,582
12/31/21 1/1/2023 1,000,000 223,807 776,193 2,021,389
Interest exp 330,660 1/1/2024 1,000,000 161,711 838,289 1,183,100
1/1/2025 1,000,000 94,648 905,352 277,748
Lease liab 669,340
1/1/2026 300,000 22,220 277,780 -
Cash 1,000,000

Journal entries
Depreciation 776,650 1/1/21
Accumulated dep 776,650 Right of use asset 4,616,280
Return of equipment to lessor Lease liab 4,516,280
12/31/24 Cash (250-150) 100.000
Interest exp 108,915

Lease liab 891,085 Lease liab 1,000,000

Cash 1,000,000 Cash 1,000,000

*the annual payment is advance, the first payment is applicable only to

the principal lease liab.
Accumulated dep 3,106,600
Interest exp 281,302
Lease liab 200,000
Accrued int. payable 281,302
Right of use asset 3,306,600

*Remaining C.A = Residual value

Depreciation 863,256
*If the fair value of the underlying asset is less than the residual value
guarantee, a loss is reported for the difference and the lessee must Accumulated dep 863,256
make up for the difference with a cash payment.

Illustration – Initial direct cost

1/1/22
On January 1, 2021, Simple Company leased an equipment
Accrued int. payable 281,302
Fixed payment in advance at the beginning of each lease year
1,000,000 Lease liab 718,698

Initial direct cost paid 250,000 Cash 1,000,000

Lease incentive received 150,000

Residual value 300,000 Interest exp 223,807

Lease term 5 years Accrued int. payable 223,807

Useful life 6 years

Implicit interest % 8% Depreciation 863,256

PV of 1 0.6806 Accumulated dep 863,256

PV of annuity of 1 in advance 4.3121 1/1/2026

*if advance ang formula is 1-[(1+%)^-n-1]/r yung total +1 Accumulated dep 4,317,280

Lease liab 277,748

PV of rentals (1M x 4.3121) 4,312,100
Accrued int. payable 22,252
PV of residual (300k x .6806) 204,180
Right of use asset 4,616,280
Lease liab 1/1/21 4,516.280

Initial direct cost 250,000

Lease incentive (150,000)

Total cost of right of use asset 4,616,280

Illustration – Unguaranteed residual value Payment of liability for restoration cost

On January 1, 2021, Ezzy Company leased a warehouse Estimated liab for restoration 634,920

Annual rental 600,000 Cash 634,920

Unguaranteed residual value 200,000 Problems

Payment to lessor to obtain long-term lease 224,000 10-11

Cost of restoring 634,920 At the beginning of the current year, East Company leased a new
machine from North Company
Annual executory cost paid 50,000
Annual rental payable 400,000
Lease term 6 years
Lease term 10 years
Useful life 8 years
Useful life 12 years
Implicit interest % 10%
Implicit interest % 14%
Discount % for the restoration cost 8%
PV of 1 for 10 periods 0.27
PV of 1 at 10% 0.56
PV of annuity in advance 5.95
PV of 1 at 8% 0.63
East Company had the option to purchase the machine upon the
PV of ordinary annuity of 1 at 10% 4.36 expiration of the lease term by paying P500,000. The purchase option is
reasonably certain to be exercised.

Initial cost of the right use of asset =

Lease liab (600k x 4.36) 2,616,000
PV of rentals 400,000 x 5.95 = 2,380,000
Payment to lessor 224,000
PV of purchase option 500,000 x .27 = 135,000
PV of restoration cost (634.92 x .63) 400,000
Right of use asset 2,515,000
Cost of right of use asset 3,240,000
10-12
*the residual value is not included because it is unguaranteed.
On December 31, 2021, Tiger Company leased equipment form another
*the annual executory cost is treated as outright expense. entity with the following data:
Depreciation 3,240,000/6 years = 540,000  The estimated 7-year useful equipment life coincided with the
lease term.
Journal entries
 The first of the 7 equal annual P800,000 lease payments was
2021 paid on December 31, 2021.
 The implicit interest rate is 12%
Right of use asset 3,240,000  Tiger Company’s incremental borrowing rate is 14%
 PV of annuity of 1 in advance at 12% is 5.11
Lease liab 2,616,000  PV of annuity of 1 in advance at 14% is 4.89
Cash 224,000 Initial measurement of the right use of asset = 800,000 x 5.11 =
4,088,000
Estimated liab for restoration 400,000
10-13

At the beginning of current year, Ashe Company entered into a 10-year

Executory cost 50,000 non-cancelable lease requiring year-end payments of 1,000,000
Cash 50,000 Ashe’s incremental borrowing rate is 12%, while the lessor’s implicit rate
is 10%

PV of ordinary annuity at 10% is 6.145

Depreciation 540,000
PV of ordinary annuity at 12% is 5.650
Accumulated dep 540,000
On the same date, Ashe Company paid initial direct cost of P200,000 in
negotiating and securing the leasing agreement.
Interest expense (400k x 8%) 32,000 Ownership of the property remains with the lessor at expiration of lease.
The leased property had an estimated economic life of 12 years.
Estimated liab for restoration 32,000
1. Right of use asset = (1M x 6.145) = 6,145,000 + 200k =
Return of equipment
6,345,000
Accumulated dep 3,240,000 2. Depreciation = 6,145,000/10 = 614,500
3. Lease liab at the end of current year = 6,145,000 x 1.1 –
Equipment 3,240,000 1,000,000 = 5,759,500
10-14 The entity had the option to purchase the equipment at the expiration of
the lease term by paying P500,000.
At the beginning of current year, Nori Company entered into a 5-year
lease for drilling equipment. There is reasonable certainty that the entity shall exercise the option.
The entity incurred initial direct cost of P200,000.
The entity accounted for the acquisition as a finance lease for
P2,400,000 which included a P100,000 purchase option. 1. Initial cost of the right of use asset
PV of rental (500k x 5.33) = 2,665,000
At the commencement date, the entity is reasonably certain to exercise PV of purchase option
the purchase option. (500k x .47) 235,000
Initial direct cost 200,000
The entity estimated the fair value of the equipment at P200,000 at the Cost of right of use asset 3,100,000
end of the 8-year life and regularly used straight line depreciation on 2. Interest expense
similar equipment. PV of rental 2,665,000
PV of purchase option 235,000
Depreciation = 2,400,000 – 200,000 = 2,200,000/8 = 275,000 2,900,000
x 10%
10-15
Interest expense 290,000
At the beginning of the current year, Evita Company entered into an 8- 3. Lease LIab
year finance lease for an equipment. 2,900,000*1.1-500,000 = 2,690,000
4. Depreciation
The entity accounted for the acquisition of the finance lease at 3,100,000/10 years = 310,000
P5,000,000 which included a P200,000 purchase option.
10-19
At the commencement date, the entity is not reasonably certain to
exercise the purchase option. On January 1, 2021, Nun Company leased machinery from Chin
Company for a 10-year period. The useful life of the asset is 20-years.
The expected fair value of the equipment is P400,000 at the end of the Equal annual payments under the lease are P200,00 and are due on
10-year useful life. The straight line depreciation is used. January 1 of each year starting January 1, 2021.

Depreciation = 5,000,000 – 200,000 = 4,800,000/8 years = 600,000 The present value on January 1, 2021 of the lease payments over the
lease terms discounted at implicit interest rate of 10% is 1,352,000.
10-16
The lease provided for a transfer of title to the lease upon expiration of
At the beginning of current year, Cola Company signed an 8-year non- the lease term.
cancelable lease for a new machine, requiring P750,000 annual
payments at the beginning of each year. 1. Lease liab – 12/31/21
1,352,000 – 200,000 = 1,152,000
The machine had a useful life of 12 years with residual value of 2. Lease liab (noncurrent) – 12/31/21
P300,000 at the end of 12 years. 1,352,000 x 1.1 – 200,000 = 1,067,200
3. Interest expense for 2021
Title passes to Cola Company at the lease expiration date, Cola 1,152,000 x 10% = 115,200
Company used straight line depreciation for all plant assets. Aggregate 4. Depreciation
lease payments have a present value of P5,400,000 based on an 1,352,000/10 = 135,200
appropriate rate of interest.
10-20
Depreciation = 5,400,000 – 300,000 = 5,100,000/12 = 425,000
Oak Company leased equipment for the entire 9-year useful life,
10-17 agreeing to pay P500,000at the start of the lease term on December 31,
2021 and P500,000 annually on each December 31 for the next 8 years.
At the beginning of current year, Janette Company entered into an 8-
year lease for an equipment. The PV on December 31, 2021, of the 9 lease payments over the lease
term, using the rate implicit in the lease which Oak Company knows to
The entity accounted for the acquisition as a finance lease for be 10% was P3,165,000.
P6,000,000 which included a P600,000 residual value guarantee. At the
end of the lease, the asset shall revert back to the lessor. The December 31, 2021 PV of the lease payments using the incremental
borrowing rate of 12% was P2,985,000.
It is estimated that the fair value of the asset at the end of the 10-year
useful life would be P400,000. The entity used the straight line Lease liab 12/31/21 = 3,165,000 – 500,000 = 2,665,000 x 1.1 – 500,000
depreciation. = 2,431,500

Depreciation = P6,000,000 – 600,000 = 5,400,000/8 = 675,000 10-21

10-18 On January 1, 2021, Blaugh Company signed a long-term lease for an

office building. The terms of the lease required Blaugh Company to pay
At the beginning of current year, Eleana Company leased an equipment P100,000 annually, beginning December 31, 2021, and continue each
from a lessor with the following pertinent information: year for 30 years.
Annual rental payable at the end of each year On January 1, 2021, the PV of the lease payments was P1,125,000 at
500,000 8% interest rate implicit in the lease.
Lease term 8 years Lease liab – 12/31/21 = 1,125,000 x 1.08 = 1,215,000 – 100,000 =
1,115,000
Useful life 10 years

Implicit interest % 10%

PV of an ordinary annuity at 10% 5.33

PV of 1 at10% 0.47
10-22 9. If the fair value of a underlying asset is greater than the
amount guaranteed by the lessee
On December 31, 2021, Rafferty Company leased equipment under a  The lessee has no obligation for excess fair value.
finance lease. Annual lease payments of P200,000 are due December 10. What is the interest rate used when the implicit interest rate
31 for 10 years. The useful life of the equipment is 10 years, and the cannot be determined?
interest rate implicit in the lease is 10%.  The lessee's incremental borrowing rate.

The lease obligation was recorded on December 31, 2021 at P1,350,000 10- 35
and the first lease payment was made on that date.
1. The lessee's lease liability for a finance lease would be
Current liab – 12/31/21 = 1,350,000 – 200,000 = 1,150,000*10% = periodically reduced by
115,000 | 200,000 – 115,000 = 85,000  Lease payment less the portion allocable to
interest.
THEORY 2. A six-year finance lease entered into on December 31 of the
current year specified equal annual lease payments due on
10-33 December 31 of each year. The first annual lease payment
paid on December 31 of the current year consists of which of
1. Under IFRS, a lessee is required to recognized
the following?
 Right of use asset and lease liability.
 Lease liability.
2. The lessee may apply the operating lease model under what
3. A six-year finance lease specified equal annual lease
condition?
payments. The lease payment in the fifth year applicable to
 Both short-term lease and low value lease.
the reduction of the lease liability should be
3. A short-term lease is defined as
 More than in the fourth year.
 Twelve months or less
4. A lessee had a ten-year finance lease requiring equal annual
4. Which statement is true about low value lease? (true lahat)
payments. The reduction of the lease liability in the second
 The value of an underlying asset is based on the
year should equal
value of the asset when new regardless of the age
 The current liability shown for the lease at the end
of the asset.
first year.
 The term of a low value lease may be more than
twelve months.
 An underlying asset does not qualify as low value
lease if the nature of the asset is such that the asset
is typically not of low value when new.
5. A right of use asset is initially measure at
 Cost
6. The cost of right of use asset comprises all of the following,
except.
 Leasehold improvements
7. The right of use asset is reported as
 Noncurrent as separate line item
8. A lessee with a lease containing a purchase option that is
reasonably certain to be exercised should depreciate the right
of use asset over
 Useful life of the asset
9. A lease liability is measured at
 The PV of lease payments
10. The lease payments include all the following, except
 Termination penalty if the lease term does not
reflect the exercise of a termination option

10-34

1. Which is not included in lease payments

 Costs for services and taxes paid by the lessee.
2. Which is not part of the lease payments?
 Any residual value at the end of the lease term.
3. The lease payments include all of the following, except
 The lessee's obligation to pay executory cost.
4. What is the cost of a right of use asset?
 The present value of the lease payments exclusive
executory costs discounted at an appropriate rate.
5. The carrying amount of the right of use asset would be
periodically reduced by
 Portion of the lease payment allocable to the
interest.
6. What is the treatment of initial direct cost incurred by the
lessee in a finance lease?
 Added to the carrying amount of the right of use
asset.
7. Which of the following statements concerning residual value
guarantee is appropriate for the lessee?
 The asset and related liability should be increased
by the present value of the residual value.
8. In computing depreciation of a right of use asset under a
finance lease, the lessee should deduct
 The residual value guarantee and depreciate over
the lease term.