Leases - A lease is defined as a contract or a part of a contract, that conveys the right to use the
underlying asset for a period of time in exchange for a consideration.
Accounting Standard Reference: PFRS 16 - LEASES
Contract: Parties Involved
Lessor: the one who owns the property that is leased or rented to the other party.
Lessee: the one who is granted the right to use the leased property.
Classification of Leases
Finance Lease - a lease that effectively transfers all the risks and rewards associated with
owning the underlying asset.
Operating Lease - a lease that does not effectively transfer all of the risks and rewards that
come with owning the underlying asset.
Indicators of Financial Lease
A lease is considered as one of the following is satisfied:
Transfer of ownership of the underlying asset to the lessee by the end of the lease term.
The lessee has the certain option to purchase the underlying asset.
The lease term is almost as equal as the economic life of the asset. Under US GAAP,
major part is equivalent to at least 75% of the economic life of the asset.
The present value of the lease payments amounts to at least substantially all the fair
value of the leased asset at the inception date. Under US GAAP, substantially all mean at
least 90% of the fair value of the leased asset.
The underlying asset undergo asset modification.
Finance Lease Accounting
The lessee will recognize a right of use asset (ROUA) and a lease liability at the
commencement date.
Lease Liability
The lease liability shall initially be measured at the present value of the lease payments at the
commencement date; meaning, it should be discounted using the implicit interest rate in the
lease. The incremental interest rate is used only if the implicit interest rate cannot be readily
determined.
Lease liability is subsequently measured using the effective interest method.
Lease liability components:
Fixed and variable lease payments less lease incentives receivable
Exercise price of the purchase option if the lessee is reasonably certain to
exercise the purchase option.
Residual value guarantee (if unguaranteed, do not include)
Termination penalties if any.
Right of Use Asset - An asset, noncurrent asset, that represents the right of the lessee to use
the underlying aset over the lease term.
The ROUA shall initially be measured at cost at the date of commencement of the lease.
Subsequently, lessee shall measure the right of use asset using the cost model.
Right of Use Asset Components:
The present value of the lease payments (initial measurement of the lease liability)
Lease payments made to lessor at or before the commencement date (lease bonus less
any lease incentives received by the lessee)
Initial direct costs incurred by the lessee.
Estimated cost of dismantling the underlying asset, lessee has a present obligation.
Right of Use Asset
The lessee shall depreciate the right of use asset over the useful life of the leased asset under
the following conditions:
Transfer of ownership at the end of the lease term
Lessee is certain to exercise a purchse option
Otherwise, ROUA shall be depreciated at the shorter between the useful life and the lease term.
ROUA is presented as a separate line item under non-current assets in the statement of financial
position; however, may be included in the appropriate line item within which the underlying
asset would be presented if owned.
PPE, if the ROUA is related to PPE. (Disclosure is needed)
Investment property. (One fits all, if the lessee is using the fair value model for
investment property, the ROUA shall also use the FV model.)
Problem 1: Finance Lease
Ariana Company leased a machinery on January 1, 2022 under a finance lease transaction
model, with the following information:
Annual rental payable at the end of each year 400,000
Residual value guarantee 200,000
Payment to lessor to obtain a long - term lease 120,000
Cost of dismantling and restoring the asset as required
by contract (at present value) 156,000
Annual executory cost paid by lessee 20,000
Lease term 4 years
Useful life of building 8 years
Implicit Interest Rate 10%
PV of an ordinary annuity of 1 for 4 periods at 10% 3.17
PV of 1 for 4 period at 10% 0.68.
The machinery will revert to the lessor at the end of the lease term.
At what amount shall the lease liability be initially measured?
At what amount shall the right of use asset be initially measured?
How much depreciation on the right of use asset shall be recognized for 2022?
How much interest expense shall be reported for the year 2022?
Problem 1: Finance Lease
On January 1, 2022, Sabrina Company leased a building from a lessor with the following
information:
Annual rental payable at the end of each year 1,250,000
Initial direct cost (including P125,000 commission to the broker
that arranged the lease) 500,000
Lessor's reimbursement for the broker's commission paid by the lessee 125,000
Leasehold improvement 250,000
Purchase option that is reasonably certain to be exercised 625,000
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
PV of 1 for 5 period at 10% 0.62
Requirements:
Initial measurement of the right of use asset.
Depreciation expense for the year, 2022.
Interest expense for the year, 2022.
Lease liability reported on December 31, 2022.
Problem 3: Activity
On December 31, 2022, Sariaya Corp. leased a machine with an economic life of 8 years from
Banahaw Corp. with the following terms:
Lease term, 5 years. Sariaya has an option to extend for an additional 3 years that it does
not
intend to exercise.
Equal annual payments, P525,000 (including P25,000 reimbursement to lessor for
annual
executory costs) due on December 31 of each year.
The first payment was made on December 31, 2022, and the second payment was made
on
December 31, 2023.
Sariaya's incremental borrowing rate is 10%.
The residual value at the end of the lease term, guaranteed by a third party, is P200,000.
Initial direct costs paid bỳ Sariaya, P120,000.
Sariaya depreciates its owned assets using the straight-line method.
Determine the following: (Round off present value factors to four decimal places.)
Cost of right-of-use asset.
Annual depreciation of the right-of-use asset.
Interest expense for 2023.
The current portion of the lease liability at December 31, 2023.
Problem 4: (Activity)
In connection with your audit Nakar Enterprises, you noted that the company has a long-
standing policy of acquiring company equipment by leasing. Early in 2025, the company entered
into a lease for new milling machine. The lease stipulates that annual payments will be made for
5 years. The payments are to be made in advance on December 31 of each year. At the end of
the 5-year period, Nakar may purchase the machine. The estimated economic life of the
equipment is 12 years. Nakar uses the calendar year for reporting purposes and straight-line
depreciation for other equipment. In addition, the following information about the lease is also
available:
Annual lease payments (including executory costs of P5,000) P60,000
Purchase option price P25,000
Estimated fair value of machine after 5 years P75,000
Implicit rate 10%
Date of first lease payment Jan. 1, 2025
Based on the foregoing and the result of your audit, compute for the following: (Round off
present value factors to four decimal places.)
Right of use asset
Carrying amount of the lease liability on December 31, 2025. (separate the current portion)
Interest expense for the year 2025.
ANS:
Statement 1 and 2 are true.
Statement 3: Net Rental income
Net Rental Income
Rental Income 2024 4800000 x9/12 = 3,600,000
Lease Bonus 900000x9/36 = 225,000
Initial Direct Cost 300000x9/36 = (75,000)
Depreciation 6000000/10 = (600,000)
Net Rental Income 3,150,000
ANS:
Rental Income / month 7200000/36 months= 200000/month
07/01/2024 to 06/30/2025 = 12 months
Rental Income on June 30,2025 200000 x 12 months = 2,400,000
Rental Income for 24 months 200,000 x 24 = 4,800,000
Cash Collected 1st year 100,000 x 12 = (1,200,000)
Cash Collected 2nd year 150,000 x 12 = (1,800,000)
Rent receivable 1,800,000
