Illustrative Problems | Leases (Direct Financing, Sales type, Sales and Leaseback)

1. Company X is in the business of leasing new sophisticated equipment. At the

beginning of current year, the equipment was delivered to a lessee under a direct
financing lease with the following provisions:
Cost of equipment P 3,390,000
Annual rental payable at the end of year 600,000
Useful life and lease term 10 years
Implicit interest rate 11%
The entity incurred and paid initial direct costs of P143,400 in negotiating and
arranging the lease. The equipment will revert to Company X at the end of the lease.

Requirements:
a. Compute the total financial revenue to be recognized over the lease term.
b. Prepare journal entries on the books of Company X for the current year.
2. On January 1, 2025, Company X leased equipment to ABC Corporation. Information
on the lease is shown below:
Cost of equipment P 330,647
Annual rental payable at the end of year 100,000
Useful life 5 years
Lease term 4 years
Implicit interest rate 10%
Residual value 20,000
The equipment will revert back to Company X at the end of the lease term. The lease
is classified as direct financing lease.

Requirements:
a. Compute for the following assuming the residual value is (1) guaranteed and (2)
unguaranteed:
 Gross investment in the lease on January 1, 2025.
 Net investment in the lease on January 1, 2025.
 Unearned interest income on January 1, 2025.
b. Prepare the journal entries under the following scenarios:
 Scenario 1: The actual fair value (residual value) of the equipment on
December 31, 2029 is P20,000 (or more).
 Scenario 2: The actual fair value (residual value) of the equipment on
December 31, 2029 is P5,000.
3. On January 1, 2025, Company X leased an equipment to another entity. The cost of
the equipment to Company X was P1,377,480 which approximates the fair value on
the lease date. The expected economic life of the equipment is also 4 years.

The lease payments stipulated in the lease are P440,000 per year in advance for a 4-
year period of the lease. The payments include P40,000 executory costs per year. The
title to the equipment remains in the hands of Company X at the end of the lease term,
although only nominal residual value is expected at that time.

The implicit interest rate in the lease is 11%. The fiscal year of Company X ends in
December 31.

Requirements:
a. Compute the total financial revenue.
b. Prepare an amortization schedule for the lease receivable and interest income.
c. Prepare journal entries for 2025, 2026, 2027 and 2028.

4. On January 1, 2025, Company X leased equipment to Company Y for an eight-year

period expiring January 1, 2033. Equal payments under the lease are P600,000 and
are due on January 1 of each year. The first payment was made on January 1, 2025.
The rate of interest contemplated is 10%.

The fair value of the equipment which is equal to the present value of lease payments
is P3,520,000, and the cost of the equipment is P2,800,000. Company X paid initial
direct costs of P50,000 in negotiating and arranging the lease. The lease is
appropriately recorded as a sales type lease.

Requirement: Prepare journal entries on the books of Company for 2025 and 2026.
5. On January 1, 2025, Company X, a dealer in equipment, leased equipment to
Company Y. The lease is appropriately accounted for as a sale by Company X and as
a purchase by Company Y. The lease is for a 10-year period which approximates the
useful life of the asset. The first of 10 equal annual payments of P500,000 was made
on January 1, 2025.

Company X purchased the equipment for P2,675,000 and established a list selling
price (fair value) of P3,375,000 on the equipment. Company X used the perpetual
inventory system.

The present value on January 1, 2025, of the rent payments over the lease term
discounted at 12% was P3,165,000.

Requirement: Prepare journal entries for 2025 and 2026 on the books of Company
X and Company Y.
6. On January 1, 2025, Company X leased equipment with ABC Corporation. Information
on the lease is shown below:
Cost of equipment P 300,000
Annual rental payable at the end of year 100,000
Useful life 5 years
Lease term 4 years
Implicit interest rate 10%
Residual value 20,000
The equipment will revert back to Company X at the end of the lease term. The lease
is classified as sales type lease.

Requirements: Compute for the following assuming the residual value is (1)
guaranteed and (2) unguaranteed:
a. Gross investment in the lease in January 2025.
b. Net investment in the lease on January 1, 2025.
c. Total interest income (finance income) to be recognized by Company X over the
lease term.
d. Sales, Cost of sales, and Gross profit recognized on the lease.
e. Provide the journal entries.
7. Company X used leases as a method of selling products and followed the perpetual
inventory system. On January 1, 2025, a machinery was leased to another entity on
a contract specifying that ownership of the machinery will transfer to the lessee at the
end of the lease term.
Cost of equipment P 6,000,000
Annual rental payable in advance 900,000
Lease term 20 years
Implicit interest rate 10%
Estimated Residual value 300,000

Requirements:
a. Determine the total financial revenue.
b. Determine the gross profit on sale.
c. Prepare journal entries for 2025 and 2026.
8. Company X is a dealer in equipment. On January 1, 2025, the entity leased an
equipment to another entity. The lease is appropriately recorded as a sales type lease.
Cost of equipment P 3,100,000
Annual rental payable in advance 875,000
Useful life 8 years
Lease term 10 years
Implicit interest rate 10%
Purchase Option 300,000
It is reasonably certain that the lessee will exercise the purchase option on the
expiration of lease on December 31, 2032 5 The perpetual inventory system is used by
Company X.

Requirements:
a. Determine the unearned interest income on January 1, 2025.
b. Determine the gross profit on sale.
c. Prepare journal entries for 2025 and 2026.
d. Prepare journal entry on December 31, 2032 5 to record the exercise of the bargain
purchase option by the lessee.
e. Prepare journal entry on December 31, 2032 5 if the bargain purchase option is not
exercised by the lessee and the fair value of the leased asset is P200,000.
9. At the beginning of current year, Company X sold an equipment to Company Y for
P1,200,000 which is the fair value of the equipment. The equipment had a cost of
P2,500,000, carrying amount of P1,000,000 and remaining useful life of 5 years. On
the same day, Company X leased back the equipment for one year for an annual rental
of P300,000 payable at the beginning of the year. Company X has no option to renew
or repurchase the equipment.

Requirement: Prepare journal entries for the current year to record the sale and
leaseback transaction on the books of Company X and Company Y.

10. On January 1, 2025, Company X sells a building to Company Y and simultaneously

leases it back. Additional information are as follows:
Fair value of building P 1,000,000
Carrying amount 800,000
Annual rental payable at the end of each year 100,000
Remaining useful life 10 years
Lease term 5 years
Implicit interest rate 12%

Requirement: Prepare the journal entries from the point of view of Company X and
Company Y: Note: for 2025 only
Scenario 1: The sale price is P1,000,000 (equal to fair value).
Scenario 2: The sale price is P1,100,000 (above fair value).
Scenario 3: The sale price is P900,000 (below fair value).