(pa-1) 46. Leases

413889810.doc

Page 1 of 19 FAR EASTERN UNIVERSITY – MANILA PRACTICAL ACCOUNTING PROBLEMS 1 LEASES

Lease. An agreement whereby the lessor conveys to the lessee in return for payment the right to use an asset for an agreed period of time. Finance lease (lease purchase). A lease that transfers substantially all the risks and rewards of ownership of an asset. Title need not necessarily be eventually transferred. Operating lease. A lease that is not a finance lease. It is a rental approach in the sense that the periodic rental is simply recognized as rent expense ( on lessee’s books) and rent income (on lessor’s books) Minimum lease payments. The payments over the lease term that are required to be made. For a lessee, this includes any amounts guaranteed to be paid; for a lessor, this includes any residual value guaranteed to the lessor. Classification of Lease Lessor  Operating Lease  Finance Lease 1. Sales – type Lease 2. Direct Financing Lease

Lessee  Operating Lease  Finance Lease

Finance lease a. Plain or regular finance lease, hereinafter referred to as direct financing lease, (FMV of lease asset is equal to the cost of lease asset) b.Finance lease by manufacturers or dealers, hereinafter referred to as sales-type lease,(FMV of lease asset is not equal to the cost of lease asset)

Whether a lease form. Situations No

is a finance lease or an operating lease depends on the substance of the transaction rather than the that would normally lead to a lease being classified as a finance lease include the following:

Is the lease contract non-cancelable? Yes

 The lease transfers ownership of the asset to the lessee by the end of the lease term;  The lessee has the option to purchase the asset at a price which is expected to be

sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised; No  At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the Does the lease contain a bargain purchase Yes option? leased asset; (Under American Standard, at least 90% of the fair value of the leased asset) Minimum Lease Payment – the payments over No the lease term that the lessee can be required to make, excluding contingent rent, cost for services and taxes to be paid and Is the lease term form a major part of the Yes asset’s useful life? reimbursed to the lessor, together with guaranteed residual value and bargain purchase option. No  The lease term is for the major part of the economic life of the asset, even Is the present value of minimum lease if title is not transferred; (Under American Standard, at least 75% of the Yes payments greater than or substantially economic life of the asset) and equal to asset’s fair value?  Other Criteria: No  The lease assets are of a specialized nature such that only the lessee can use them without major modifications being made. Yes Is the asset so special in nature that only the lessee can use it without modification?  If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee. No  Gains and losses from the fluctuation in the fair value of the residual accrue to the lessee, for example, in the form of a rent rebate equaling most of the sales proceeds at the end of the lease. Operating Lease Finance Lease  The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent. Is ownership transferred by the end of the vdjksjkjkdjcacacacancelable lease term?

Yes

ACCOUNTING FOR OPERATING LEASE

OPERATING LEASE ON THE VIEWPOINT OF LESSOR AND LESSEE Rent expense/Rental receipts

Free rent/ Uneven payments

Lessee

Lessor

Rent expense – lessee does not record the leased asset; instead, the periodic rental payment is recognized as rent expense on a straight line basis Rental expense is still recognized by lessee on a SL basis and is prorated over full term of

Rental receipts – recognized as rental revenue of a SL basis Rental revenue is still recognized by lessor on a SL basis and is prorated over full term of lease

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Lease bonus Security deposits

Leasehold improvement

Page 2 of 19 Lessee

Lessor

lease Treated as prepaid rent and amortized as rental expense over the lease-term on a SL basis If refundable is treated as a receivable (asset) by the lessee until the deposit is returned to the lessee

Treated as Unearned rent by lessor and amortized as rental revenue over the lease term on a SL basis If refundable is treated as a payable (liability) by the lessee until the deposit is returned to the lessee

If nonrefundable is recorded as prepaid rent and amortized as rental expense over the lease term

If nonrefundable is recorded as unearned revenue and recognized as rental revenue over the lease term

Leasehold improvement – capitalized by lessee and amortized over the shorter of the remaining lease term or the useful life of the improvements Classified - Property, plant and equipment

Expense matched against rent revenue

a. Depreciation of the leased asset – Lessor depreciates the asset over asset’s economic life (regardless of the date the lease term begins) b. Initial direct costs – are recorded as an asset by the lessor and amortized on a SL basis to operating expense over the lease term c. Executory costs – insurance, property tax, repairs on the leased asset usually paid by lessor are charged to operating expense as incurred.

Pro-forma Entries 1. Lease payments

2. Contingent rental

Lessee's Books Rent expense Cash Rent expense Cash

Xxx

Prepaid rent Cash

Xxx

Rent expense Prepaid rent

Xxx

4. Security deposit ( refundable upon lease Expiration)

Rent deposit Cash

Xxx

5. Lease improvements

Lease improvements Cash

xxx

3. Lease bonus

Amortization

Depreciation

Depreciation expense xxx Accum. Depreciation - LI

6. Leased property ( recognized as asset and shall be depreciated consistent with the lessor's normal depreciation for similar asset)

Not applicable

7. Initial direct cost ( added to the carrying amount of the leased asset and recognized as an expense over the lease term of the same basis as the lease income)

Not applicable

xxx

Lessor's Books Cash Rent income Cash Rent income

xxx

xxx

xxx

xxx

Cash Unearned income Unearned income Rent income

xxx

xxx

Cash Liability for rent deposit

xxx

xxx

Xxx

xxx xxx

xxx

xxx

xxx

xxx

Not Applicable xxx

xxx Leased property Cash

xxx xxx

Depreciation expense xxx Accumulated depreciation

xxx

Deferred initial direct cost Cash

xxx

xxx

Amortization of IDC xxx Deferred initial direct cost

xxx

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Financial Statement Presentation Lessee Prepaid rent Rent deposit Leasehold improvement (if any) Less: Accumulated depreciation

Statement of financial position

Statement of comprehensive income

Lessor Leased property Less: Accumulated depreciation Deferred IDC - net of amortization Liability for rent deposit Unearned rent income

Rent expense Depreciation expense - LI

Rent income Depreciation expense Amortization of IDC ACCOUNTING FOR FINANCE LEASE (Lessee’s Point of View)

Note of Guaranteed and Unguaranteed Residual Value: (Computation for Present Value) Lessee book  guaranteed only Lessor book  Either guaranteed or unguaranteed included in the computation Note: the guaranteed residual value is not included in the lease liability if it is guaranteed by a third party (lessee not included) ( lessor included)

Journal Entries under finance lease on the books of the Lessee 1. To record the lease at the commencement of the lease term Leased property under finance lease Obligations under finance lease Lower between : FV of the leased asset and PV of minimum lease payment Total leased asset/ liability: PV of rental payments required during the lease term (annual rental x * annuity factor) xxx PV of BPO payment ( BPO x PV of 1 factor) xxx PV of guaranteed residual value ( in the absence of BPO) (GRV x *PV of 1 factor) xxx PV of MLP (a ) xxx Compared with the Fair value of leased asset (b)

xxx

Total leased asset/ liability ( the lower amount a or b)

xxx

xxx Xxx

* The discount rate is the interest rate implicit in the lease, if determinable, Otherwise the lessee’s incremental borrowing rate. Note: a. BPO ( There is a bargain purchase option if the option price is less than the fair value of the asset upon the option exercise date). b. Guaranteed RV is not included,(if guaranteed is not related to the lease contract) or if there is no indication that the third party is related to the lessee. 2. To record periodic lease payments Obligations under finance lease ( periodic rental payment minus interest) Interest expense (PV x interest rate) Cash

xxx xxx Xxx

(PV = balance of the leased liability – principal) 3. To record depreciation on the leased property Depreciation expense - leased property

xxx

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Accu. Depreciation - leased property

Xxx

Note: If there is transfer of ownership or there is bargain Purchase option, depreciate using the useful life of the Leased asset. If there is no transfer of ownership, use the shorter Of the useful life of leased asset or lease term. 4. To record transfer of ownership of the leased property at the end of the lease term Asset Accu. Depreciation – leased property Leased property under finance lease

xxx xxx Xxx

5. To record the exercise of the bargain purchase option upon lease expiration Asset Accu. Depreciation – lease property Lease liability Interest expense

xxx xxx xxx xxx

Cash Leased property under finance lease

xxx xxx

6. To record return of the leased asset to the lessor if the bargain purchase option is not Accumulated depreciation – leased asset Leased liability Interest expense Loss on finance leased ( Book value of leased asset minus lease liability balance) Leased asset

exercised xxx xxx xxx xxx Xxx

7. To record return of the leased asset to the lessor upon leased expiration and there is guaranteed residual value (GRV) a. if the residual value of leased asset is EQUAL to its fair value upon lease expiration, then no payment of GRV of the lessor. Accumulated depreciation – leased asset Leased liability Interest expense Leased asset

xxx xxx xxx xxx

b. if the fair value of leased asset is LESSER than the GRV upon lease expiration, then the lessee pays the difference between the GRV and the fair value of leased asset to the lessor. Accumulated depreciation – leased asset Leased liability Interest expense Leased asset Loss on finance leased ( difference between the FV and GRV) Cash

xxx xxx xxx xxx xxx xxx

Lessee's Statement of financial position Assets Leased Property : Finance leases, less accumulated depreciation Liabilities Current liabilities: Obligations under finance lease Noncurrent liabilities: Obligations under finance lease

Lessee’s Statement of comprehensive income Operating expenses

Depreciation expense – leased asset

Other expense

Interest expense

ACCOUNTING FOR FINANCE LEASE (Lessor’s Point of View)

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Summary: 1. Lessors shall recognized a receivable at an amount equal to the net investment in the lease 2. The lease payment receivable is treated by the lessor as repayment of the principal and finance income 3. The finance income is allocated over the lease term using the effective interest method 4. Initial direct cost are treated as follows: a. For finance lease other than those involving manufacturer dealer lessor – initial direct cost are included in the initial measurement of the finance lease receivable and reduce the amount of income recognized over the lease term b. Cost incurred by manufacturer or dealer lessors in connection with negotiating and arranging finance lease are recognized as expense when selling profit is recognized 5. Manufacturer or dealer lessor recognizes two types of income: a. selling profit or loss b. finance income over the lease term Lessor

Direct Financing Lease - A financing company

Sales Type Lease - A manufacturer or a dealer

Cost vs. FV of leased asset

- Cost = FMV

- Cost is not equal to FMV

Income or revenue

- Interest income

- Selling profit - Interest income

Gross investment

- MLP + RV

- MLP + RV

- Equal to the gross rental for the entire term plus the absolute amount of the residual value, whether guaranteed or unguaranteed

- Equal to the gross rentals for the entire lease term plus the absolute amount of the residual value, whether guaranteed or unguaranteed.

- The amount debited to lease receivable

- same as direct financing lease.

- PV* of MLP + PV of RV + IDC **

- PV* of MLP + PV of RV

- Equal to the cost of the asset plus any initial direct cost paid by the lessor

- Equal to the present value of the gross rentals plus the present value of the residual value, whether guaranteed or unguaranteed.

Unearned interest income

- The total financial revenue of the lessor which is the difference between the gross investment and net investment in the lease

- The total financial revenue of the lessor which is the difference between the gross investment and net investment in the lease. - Sale as direct financing lease

Initial direct cost

- The initial direct cost paid by the lessor is added to the cost of the asset to get the net investment in the lease. (added to net investment in the lease) - This would effectively spread the initial direct cost over the lease term and reduce the amount of interest income. - The interest implicit in the lease is recomputed so as to include the initial direct cost in the measurement of the receivable.

- Expensed immediately is a sales type lease as component of cost of sales. (added to cost of sales)

Net investment in the lease

Notes: * Interest rate implicit in the lease is used in PV calculations ** Initial direct costs are capitalized and allocated over the lease term. Likewise, IDC reduces the implicit interest rate to the lessor. Legend: FMV – fair market value PV – present value MLP – minimum lease payment IDC – initial direct cost URV – unguaranteed residual value CGS – cost of goods sold

A. DIRECT FINANCING LEASE Direct Finance Lease To record the lease MLP Receivable (Gross) Leased asset (PV + IDC) Unearned Interest Revenue

Xxx Xxx Xxx

To record the cost of sales Not applicable To record collection of leased payments

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Cash

Xxx MLP Receivable

To record amortization of interest Unearned Interest Revenue * Interest revenue

Xxx

Xxx Xxx

Note : * Unearned interest income is amortized over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease ( effective interest method).

COMPUTATIONS 1. Direct Finance Lease with Initial Direct Cost a. The initial direct cost should be added

to the cost of the asset to determine the net investment.

Cost of asset Add: Initial direct cost

Xxx Xxx

Net investment in the lease

Xxx

b. Computation of unearned interest income Gross rental Less: Net investment in the lease Unearned interest income

Xxx (xxx) Xxx

2. Direct Financing Lease with Residual Value a. The present value of the residual value is deducted from the cost of the asset to determine the net investment

if the asset

will revert to the lessor at the end of the lease term. Cost of asset Less: PV of residual value Net investment to be recovered from rental Divide by PV of an ordinary annuity of 1 at ___% for ___ periods Annual rental

Xxx (xxx) Xxx Xxx Xxx

Note: The present value of the residual value is IGNORED in computing the net investment if the asset will NOT revert to the lessor at the end of the lease term.

b. Computation of unearned interest income Gross rentals add: residual value ( whether guaranteed or unguaranteed) Gross investment Less: Cost of machinery - net investment Unearned interest income

Xxx Xxx Xxx (xxx) Xxx

Note : if the leased asset will not revert to the lessor at the end of the lease term because the lease provides for a transfer of title to the lessee, the residual value is completely ignored in the computation of the annual rental and the unearned interest income. B. SALES TYPE LEASE  At the commencement of the lease term, the lessor recognizes: Sales revenue = FMV of the asset, or if lower, the PV of MLP computed at a market rate of interest Cost of goods sold = cost, or carrying amount if different, of the leased asset less the PV of URV plus IDC Selling profit (gross profit) = difference between the sales revenue and the CGS 

Two types of income in a sales type lease: a. Selling profit or gross profit – it is recognized in full at the commencement of the lease term. b. Finance income – (Gross investment less net investment). It is recognized over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. Sales Type Lease To record the lease MLP Receivable Sales Unearned Interest Revenue To record cost of sales Cost of goods sold Inventory

xxx Xxx Xxx

xxx Xxx

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To record collection of leased payments Cash MLP Receivable

xxx

To record amortization of interest Unearned Interest Revenue* Interest revenue

xxx

Xxx

Xxx

Note: * unearned interest income is amortized over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease ( effective interest method). COMPUTATIONS

1. The lease receivable and unearned interest income are the same whether the scenario is guaranteed or unguaranteed residual value. Gross rentals Add: guaranteed/unguaranteed residual value Lease receivable - gross investment

PV of gross rentals Add: PV of residual value Total present value - net investment

Lease receivable Less: Total present value Unearned interest income

Xxx Xxx Xxx

Xxx Xxx Xxx Xxx (xxx) Xxx

2. Computation of sales and cost of sales:

a. Under the “guaranteed residual value scenario,” the present value of the guaranteed residual value is included in the sales revenue because the lessor knows that the entire asset has been sold. Sales ( equal to the total PV PLUS guaranteed residual value) or FMV of the asset (whichever is lower) Less: cost of sales - cost of machinery Less: initial direct cost Gross income

Xxx (xxx) (xxx) Xxx

b. Under the “unguaranteed residual value scenario,” the present value of the unguaranteed residual value is not included in the sales revenue. Sales ( equal to present value of gross rentals ONLY) Less: cost of sales - cost of machinery MINUS unguaranteed residual value Less: initial direct cost Gross income

Xxx (xxx) (xxx) Xxx

NOTE: The present value of the unguaranteed residual value is deducted from the cost of the leased asset in computing cost of sales because this portion of the leased asset is in effect “not sold” in the sense that the lessor will be receiving backed at the end of the lease term the leased asset with unguaranteed residual value.

ACCOUNTING FOR SALE – LEASEBACK TRANSACTIONS SALE AND LEASEBACK TRANSACTIONS  If sale and leaseback transactions results in a finance lease a. Excess of sales proceeds over the carrying amount of the asset shall not be immediately recognized as income by a seller-lessee b. The excess shall be deferred and amortized over the lease term Sales proceeds xxx Less: CV xxx Gain or (loss) xxx(xxx) Gain - deferred and amortized over the lease term Loss- recognized immediately 

If a sale and leaseback transaction results in an operating lease a. Sales price equal to fair value – any profit or loss is recognized immediately

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413889810.doc Page 8 of 19 b. Sales price below fair value – an profit or loss is recognized immediately except that if loss is compensated for by future lease payments at below market price, the loss is deferred and amortized in proportion to the lease payments over the period the asset is expected to be used c. Sales price above fair value – excess over fair value shall be deferred and amortized over the period the asset is expected to be used and the excess of the fair value over the carrying amount is an outright gain Sale – leaseback as a FINANCE LEASE  IAS 17 provides that “if the sale and leaseback transaction results in a finance lease, any excess of sale proceeds over the carrying amount should not be immediately recognized as income but DEFERRED and amortized over the lease term.”  If the leaseback is a finance lease, any GAIN on sale and leaseback is DEFERRED and amortized over the lease term, but any LOSS on sale and leaseback is recognized IMMEDIALTELY.



Pro-forma entries Seller-Lessee's books

To record the sale of asset

To record the leaseback as finance lease

Buyer- Lessor's books

Cash

xxx

Accumulated depreciation

xxx Xxx

Deferred gain on sale and leaseback

xxx

Equipment - leased asset

xxx

Earned over the lease term

xxx

Equipment

xxx

Unearned interest income

xxx

Interest expense

xxx

Cash

xxx

Lease liability

xxx

Unearned interest income

xxx

Depreciation expense

Xxx

xxx

Accumulated depreciation To record amortization of the deferred gain as

xxx

Lease receivable Xxx

Cash

To record the depreciation of the leased asset

xxx

Cash

Equipment

Lease liability

To record the periodic rental payment

Equipment

Deferred gain on sale and leaseback Gain on sale and leaseback

Leased receivable

xxx

Interest income

xxx

None Xxx

xxx

Unearned interest income Xxx

Interest income

xxx xxx

Sale – leaseback as a OPERATING LEASE For a transaction that results in Sale – Leaseback as an operating lease:  If the transaction is clearly carried out at fair value - the profit or loss should be recognized immediately;  If the sale price is below fair value - profit or loss should be recognized immediately, except if a loss is compensated for by future rentals at below market price, the loss it should be amortized over the period of use;  If the sale price is above fair value - the excess over fair value should be deferred and amortized over the period of use; and  If the fair value at the time of the transaction is less than the carrying amount - a loss equal to the difference should be recognized immediately. A. if sale – leaseback is ESTABLISH ( Sales price = Fair value)  Any GAIN or LOSS shall be recognized immediately  CV < FV = Gain  CV > FV = Loss B. if sale – leaseback is NOT ETABLISHED at FV (SP < FV)  Any GAIN or LOSS shall be recognized immediately  CV < FV = Gain  If the LOSS is compensated by future lease rental at below market rate, the LOSS is deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used.  If the LOSS is NOT compensated by future lease payments at below market value, the LOSS is recognized immediately. C. if sale – leaseback is NOT established at FV (SP >FV)  If the sales price is above fair value, the excess over fair value is deferred and amortized over the period for which the asset is expected to be used.  The excess of fair value over the carrying amount is an outright GAIN.

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Page 9 of 19 SP Deferred

Selling price Fair value

Note

Deferred

Selling price

Immediately

Selling price

Immediately

FV CV

Immediately

Note

If the LOSS is compensated by future lease rental at below market rate, the LOSS is deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used.

Pro-forma Entries: To record the sale of asset

To record the depreciation of the leased asset

To record the periodic rental payment

Seller-Lessee's books Cash Accumulated depreciation Equipment Gain on sale of leaseback

Buyer- Lessor's books Equipment xxx Cash

Xxx Xxx

None

Depreciation expense xxx Accumulated depreciation

Rent expense Cash

xxx

xxx xxx

Xxx

Cash xxx

xxx Rent income

xxx

xxx

Exercises Exercise No. 1 (Operating Lease) Lessor Company purchased a machine on January 1, 2010, for P1,250,000 for the express purpose of leasing it. The machine was expected to have a 9-year life from January 1, 2010, no salvage value, and to be depreciated on a straight-line basis. On March 1, 2010, Lessor leased the machine to Lessee Company for P300,000 a year for a 4-year period ending February 28, 2014. The appropriate interest rate is 12% compounded annually. Lessor paid a total of P15,000 for maintenance, insurance, and property taxes on the machine for the year ended December 31, 2010. Lessee paid P300,000 to Lessor on March 1, 2010. Lessor retains title to the property and plans to lease it to someone else after the 4-year lease period. Required: Prepare the 2010 journal entries relating to the lease on (1) Lessor Company’s books and (2) Lessee Company’s books. SOLUTION GUIDE: LESSOR'S BOOKS Debit To purchase of machine Machinery Cash To record receipt of advance rental Cash Rent income

1,250,000 1,250,000

300,000 300,000

To record payment of executory costs Expenses Cash

15,000

To recognized unearned rent Rent income Unearned rent income

50,000

To record depreciation Depreciation Accumulated depreciation

Credit

15,000

50,000

138,889 138,889

LESSEE'S BOOK Debit To record payment of advance rental Rent expense

Credit

300,000

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Cash To recognize prepaid rent Prepaid rent Rent expense

50,000 50,000

QUIZZER –OPERATING LEASE 1. On January 1, 2010, Jacklyn Company signed a 3-year operating lease for office space at P3,000,000 per year. The lease included a provision for additional rent of 10% of annual company sales in excess of P15,000,000. Jacklyn Company’s sales for the year ended December 31, 2010 amounted to P20,000,000. Upon execution of the lease, Jacklyn Company paid P1,200,000 as a bonus for the lease. What is the rent expense for the year ended December 31, 2010? a. P3,500,000 b. P5,400,000 c. P3,900,000

d. P4,700,000

2. On July 1, 2010, Rinna Company leased office space for five years at P150,000 a month. On that date, Rinna Company paid the lessor the following amounts: Rent security deposit P350,000 First month's rent 150,000 Last month's rent 150,000 Nonrefundable reimbursement for modifications to the leased premises 900,000 Rinna Company made timely rental payments from August 1 through December 1, 2010. What portion of payments to the lessor should Rinna have recognized as deferred to years beyond 2010? a. P1,400,000 b. P1,310,000 c. P1,250,000 d. P500,000 3. As an inducement to enter a lease, a lessor grants to Rose Company, a lessee, six months of free rent under a five-year operating lease. The lease is effective on July 1, 2010, and provides for monthly rental of P150,000 to begin January 1, 2011. In the income statement for the year ended June 30, 2011, what amount should be reported as rent expense? a. P1,800,000 b. P1,620,000 c. P810,000 d. P900,000 4. On October 1, 2010, Kim Company leased office space at a monthly rental of P300,000 for 10 years expiring September 30, 2020. As an inducement for Kim Company to enter into the lease, the lessor permitted Kim Company to occupy the premises rent-free from October 1 to December 31, 2010. For the year ended December 31, 2010, what amount should Kim record rent expense? a. P900,000 b. P292,500 c. P877,500 d. 0 5. On January 1, 2010, Natasha Company leased a building to a lease under an operating lease for three years at P4,800,000 per year, payable the first day of each lease year. Natasha Company paid P600,000 to a real estate broker as a finder’s fee. The building is depreciated P500,000 per year. Natasha Company incurred property tax expense totaling P100,000 for 2010. What amount should be reported as net rental income? a. P4,000,000 b. P3,600,000 c. P4,800,000

d. P4,500,000

6. Zara Company purchased a new machine for P6,000,000 on January 1, 2010 for the purpose of leasing it. The machine has an estimated 10-year life. On April 1, 2010, Zara Company leased the machine to a lessee for three years at a monthly rental of P400,000. The lessee paid the rental for one year of P4,800,000 on April 1, 2010 and additionally paid P900,000 to Zara Company as a lease bonus to obtain the three-year lease. On April 1, 2010, Zara Company incurred initial direct cost of P300,000. What is the net rental income on this leased asset for 2010? a. P3,150,000 b. P4,350,000 c. P3,200,000

d. P4,400,000

7. On July 1, 2009, Helen Company leased an equipment to another entity under a 3-year operating lease. Total rent for the lease term is P3,600,000, payable P50,000 monthly for the first lease year, P75,000 monthly for the second lease year and P175,000 monthly for the third lease year. All payments were made when due. In Helen Company’s June 30, 2011 statement of financial position, what amount should be reported as accrued rent receivable? a. P2,100,000 b. P1,200,000 c. P900,000 d. 0 8. On January 1, 2010, Mineriza Company leased a building to another entity under a 10-year operating lease at an annual rental of P1,000,000. At the inception of the lease, Mineriza Company received P4,000,000 covering the first two year’s rent of P2,000,000 and a security deposit of P2,000,000. The deposit will be applied to payment of rent for the last two years of the lease. What portion of the P4,000,000 should be shown as current and noncurrent liability, respectively? a. P2,000,000 and P1,000,000 c. P1,000,000 and P2,000,000 b. P2,000,000 and P2,000,000 d. 0 and P3,000,000 Exercise No. 2 (Finance Lease with BPO)-Lessee Lessee Enterprises has a long-standing policy of acquiring company equipment by leasing . Early in 2010, the company entered into a lease for a new equipment. The lease stipulates that annual payments will be made for 5 years. The payments are to be in advance on December 31 of each year. At the end of the 5-year period, Lessee may purchase the equipment. The estimated economic life of

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413889810.doc Page 11 of 19 the equipment is 12 years. Lessee 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 payment (including executory costs of P5,000) Purchase option price Estimated fair value of equipment after 5 years Implicit rate Date of first lease payment

P60,000 25,000 75,000 10% January 1, 2010

REQUIRED: 1. Prepare the 2010 journal entries relating to the lease on the books of Lessee (Round off present value factors to four decimal places). 2. Prepare the journal entry to record the exercise of the purchase option. 3. Prepare the journal entry at the end of the lease term if the purchase option is not exercised.

SOLUTION GUIDE: Debit

Credit

January 1, 2010 To recognize asset and liability Equipment under finance lease Finance lease liability

244,868

To record initial payment Finance lease liability Cash

55,000 55,000

To record payment for executory costs Expenses Cash

5,000 5,000

December 31, 2010 To recognize the second payment Interest expense Finance lease liability Cash

18,987 36,103 55,000

To record payment for executory costs Prepaid expenses Cash

5,000 5,000

To record depreciation Depreciation expense Accumulated depreciation

20,406 20,406

REQUIREMENT NO. 2 Interest expense Finance lease liability Accumulated depreciation Equipment Cash Equipment under finance lease

15,386 39,614

55,000

REQUIREMENT NO. 3 Interest expense Finance lease liability Accumulated depreciation Loss on finance lease Equipment under finance lease

2,268 22,732 102,028 117,840 244,868

Amortization schedule: Date 1/1/10 1/1/10 12/31/2010 12/31/2011 12/31/2012 12/31/2013

Payment

Interest

Principal

55,000 55,000 55,000 55,000 55,000

18,987 15,385 11,424 7,066

55,000 36,013 39,615 43,576 47,934

Carrying amount 244,868 189,868 153,855 114,240 70,664 22,731

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Page 12 of 19 25,000

2,269

22,731

(0)

Exercise No. 3 (Finance Lease with Guaranteed Residual Value) Lessee On January 1, 2010, Lessee Company entered into a lease contract with Lessor Company for a new equipment that had a selling price of P2,120,000. The lease contract provides that annual payments of P420,000 will be made for 6 years. Lessee made the first payment on January 1, 2010, subsequent payments are made on January 1 of each year. Lessees guarantees a residual value of P367,122 at the end of the lease term. After considering the guaranteed residual value, the rate implicit in the lease is determined to be 12%. Lessee has an incremental borrowing rate of 15%. The economic life of the equipment is 9 years. Lessee depreciates its equipment using straight line method. Required: 1. Prepare the 2010 and 2011 journal entries relating to the lease on the books of Lessee (Round off present value factors to four decimal places). 2. Prepare the journal entry at the end of the lease term if the fair value of the leased asset is P400,000. 3. Prepare the journal entry at the end of the lease term if the fair value of the lease asset is P300,000.

SOLUTION GUIDE: Debit January 1, 2010 To recognize asset and liability Equipment under finance lease Finance lease liability To record initial payment Finance lease liability Cash December 31, 2010 To record accrual of interest Interest expense Interest payable

Credit

21,200,000

420,000 420,000

204,000 204,000

To record depreciation Depreciation expense Accumulated depreciation

January 1, 2011 To record the second payment Interest payable Finance lease liability Cash December 31, 2011 To record accrual of interest Interest expense Interest payable

204,000 216,000 420,000

178,080 178,080

To record depreciation Depreciation Accumulated depreciation

REQUIREMENT NO. 2 (FV > GRV) To record return of equipment to lessor Interest payable Finance lease liability Accumulated depreciation Equipment under finance lease REQUIREMENT NO. 3 (FV
39,337 327,785 1,752,878 2,120,000

39,337 327,785 1,752,878 2,120,000

67,122 67,122

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413889810.doc Amortization schedule Date Payment 1/1/10 1/1/10 420,000 1/1/11 420,000 1/1/12 420,000 1/1/13 420,000 1/1/14 420,000 1/1/15 420,000 1/1/16 367,122

Page 13 of 19 Interest

Principal 420,000 216,000 241,920 270,950 303,464 339,880 327,785

204,000 178,080 149,050 116,536 80,120 39,337

Carrying amount 2,120,000 1,700,000 1,484,000 1,242,080 971,130 667,665 327,785 0

QUIZZER - FINANCE LEASE-LESSEE 1. Raiza Company leased an equipment from a lessor on January 1, 2010 with the following pertinent information: P50 Annual rental payable at the end of each year 0,000 Lease term 8 years Useful life of equipment 10 years Implicit interest rate 10% PV of an ordinary annuity of 1 for 8 periods at 10% 5.33 Present value of 1 for 8 periods at 10% 0.47 Raiza Company has the option to purchase the equipment on January 1, 2018 by paying P500,000 which is significantly less than the expected fair value of the equipment on the option exercise date. There is reasonable certainty that Raiza Company will exercise the option. On January 1, 2010, Raiza Company incurred initial direct cost of P200,000. What is the initial cost of equipment? a. P2,900,000 b. P3,100,000

c. P2,865,000

d. 0

2. On January 1, 2010, Olivette Company leased two automobiles for executive use. The lease requires Olivette Company to make five annual payments of P1,000,000 beginning January 1, 2010. At the end of the lease term, December 31, 2014. Olivette Company guaranteed the residual value of the automobiles at P500,000. The lease qualifies as a finance lease. The interest rate implicit in the lease is 10% and present value factors at 10% are as follows: For an annuity due with 5 payments 4.17 For an ordinary annuity with 5 payments 3.79 Present value of 1 for 5 periods 0.62 What is the principal finance lease liability on December 31, 2011? a. P3,928,030 b. P2,828,000 c. P3,100,000

d. P3,510,000

3. On January 1, 2010, Gianne Company entered into a 6-year lease with a lessor. Annual lease payments of P1,200,000 including annual executory cost of P200,000 are payable at the end of each year. Gianne Company knows that the lessor expects a 10% return on the lease. Gainee Company has a 12% incremental borrowing rate. The equipment is expected to have an estimated useful life of 6 years. In addition, a third party guaranteed to pay the lessor a residual value of P400,000 at the end of the lease. The present value of an ordinary annuity of 1 for 6 years at 10% is 4.35 and at 12% is 4.11. The present value of 1 at 10% for 6 periods is 0.56 and at 12% for 6 periods is 0.51. In the December 31, 2010 statement of financial position, what is the principal amount of the lease obligation? a. P3,785,000 b. P4,031,400 c. P4,616,800 d. P4,542,000 4. Roche Company leased machinery for 10 years, its useful life, with effect from January 1, 2010. At that date, the fair value of the machinery was P4,900,000. Annual rentals of P700,000 are payable in advance on January 1 and the interest rate implicit in the lease is 9%. The first rental payment was made on January 1, 2010. What is the total lease liability (principal and interest) which Roche Company should recognize in its statement of financial position on December 31, 2010? a. P4,578,000 b. P4,641,000 c. P700,000 d. 0 5. On December 31, 2010, Deanne Company leased equipment under a finance lease. Annual lease payments of P400,000 are due December 31 for 10 years. The equipment’s useful life is 10 years, and the interest rate implicit in the lease is 10%. The lease obligation was recorded on December 31, 2010 at P2,700,000 and the first lease payment was made on that date. What amount should Deanne Company include its current liabilities in relation to the finance lease in its December 31, 2010 statement of financial position? a. P130,000 b. P170,000 c. P230,000 d. P400,000 6. On January 1, 2010 Jessica Company entered into an 8-year finance lease for an equipment Jessica Company accounted from the acquisition of the finance lease at P5,000,000, which includes a P200,000 bargain purchase option. At the end of the lease, Jessica Company expects to exercise the bargain purchase option. The expected fair value of the equipment is P400,000 at the end of its 10year life. The straight line deprecation is used. What amount of depreciation should be recognized by Jessica for 2010? a. P575,000 b. P460,000 c. P600,000

d. P480,000

7. On January 1, 2010, Veronica Company entered into an 8-year lease for an equipment Veronica Company accounted for the acquisition as a finance lease for P6,000,000 which includes a P600,000 guaranteed residual value. At the end of the lease, the asset

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413889810.doc Page 14 of 19 will revert back to the lessor. It is estimated that the asset’s fair value at the end of its 10-year useful life will be P200,000. Veronica Company regularly uses the straight line depreciation on similar equipment. For the year ended December 31, 2010, What amount should Veronica Company recognize as depreciation expense on the lease asset? a. P675,000 b. P725,000 c. P540,000 d. P580,000 Exercise No. 4 (Direct Finance Lease) Lessor (Unguaranteed Residual Value) Lessor Controls Corporation is in the business of leasing equipment. Lessor Controls purchased a new equipment on December 31, 2010. The equipment was delivered the same day (by prior arrangement) to Lessee investment Company, a lessee. The corporation accountant revealed the following information relating to the lease transaction: Cost of equipment to Lessor Controls P550,000 Estimated useful life and lease term 8 years Expected residual value (unguaranteed) 40,000 Lessor Control’s implicit rate of interest 12% Lessee’s incremental borrowing rate 14% Additional information is as follows: (a) At the end of the lease, the equipment will revert to Lessor Control. (b) Lessee is aware of Lessor Controls rate of implicit interest. (c) The lease rental consist of equal annual payments. REQUIRED: Prepare the 2010 and 2011 journal entries relating to the lease on the books of Lessor Controls and Lessee Investment Company (Round off present value factors to four decimal places.) Debit LESSOR'S BOOKS December 31, 2010 Commencement of finance lease Finance lease receivable Equipment (cost plus initial direct cost) Discount on FLR To record initial payment Cash Finance lease receivable December 31, 2011 To record the second payment Cash Finance lease receivable To record amortization of discount on FLR Discount on FLR Interest income

807,600 550,000 257,600

95,950 95,950

95,950 95,950

54,486 54,486

LESSEE'S BOOKS December 31, 2010 To recognize asset and liability Equipment under finance lease Finance lease liability To record initial payment Finance lease liability Cash December 31, 2011 To record the second payment Interest expense Finance lease liability Cash To record depreciation Depreciation Accumulated depreciation

Credit

533,844

95,950 95,950

52,547 43,403 95,950

66,731 66,731

Amortization schedule - lessor (guranteed or unguaranteed, included in PV amount) Date Payment Interest Principal Carrying amount 12/31/2010 550,000

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413889810.doc 12/31/2010 95,950 12/31/2011 95,950 12/31/2012 95,950 12/31/2013 95,950 12/31/2014 95,950 12/31/2015 95,950 12/31/2016 95,950 12/31/2017 95,950 12/31/2018 40,000

Page 15 of 19 54,486 49,510 43,938 37,696 30,706 22,876 14,107 4,280

95,950 41,464 46,440 52,012 58,254 65,244 73,074 81,843 35,720

454,050 412,586 366,146 314,134 255,880 190,636 117,562 35,719 (0)

Amortization schedule - lessee (guranteed included / (unguaranteed not included), in PV amount) Date Payment Interest Principal Carrying amount 12/31/2010 533,844 12/31/2010 95,950 95,950 437,894 12/31/2011 95,950 52,547 43,403 394,491 12/31/2012 95,950 47,339 48,611 345,880 12/31/2013 95,950 41,506 54,444 291,436 12/31/2014 95,950 34,972 60,978 230,458 12/31/2015 95,950 27,655 68,295 162,163 12/31/2016 95,950 19,460 76,490 85,673 12/31/2017 95,950 10,278 85,672 0 Exercise No. 5– Sales Type Lease With Residual Value (Guaranteed vs Unguaranteed Residual Value) Sales Type Lease With Residual Value Note: For the Residual Value Account Residual Value

Sales Type Lease – (Will revert to the lessor upon termination of the contract) Included by the lessor – in the computation of the unearned interest income and gross profit

Sales Type Lease – (Will not revert to the lessor upon termination of the contract) Ignored by the lessor – in the computation of the unearned interest income and gross profit

XYZ Company is a dealer in machinery. On January 1, 2005, a machinery was leased to another entity with the following provisions: Annual rental payable at the end of each year P 800,000.00 Lease term 5 years Useful life of machinery 5 years Cost of machinery P2,000,000.00 Estimated residual value P 200,000.00 Initial direct costs paid by lessor P100,000.00 Implicit interest rate 10% Present value of an ordinary annuity of 1 for 5 periods at 10% 3.7908 Present value of 1 for 5 periods at 10% 0.6209 At the end of the lease term on December 31, 2009, the machinery will revert to XYZ Company. The perpetual inventory system is used. (Prepare the necessary journal entries in the books of Lessor) Guaranteed Residual Value

Unguaranteed Residual Value

Gross rentals Add: Guaranteed residual value Gross Lease Receivables

Gross rentals Add: unguaranteed residual value Gross Lease Receivables

PV of Gross rentals Add: PV of Guaranteed residual value MLP

PV of Gross rentals Add: PV of Unguaranteed residual value MLP

PV of Gross rentals Add: PV of Guaranteed residual value Total Sales

PV of Gross rentals

Cost of machinery

Cost of machinery Less: PV of Unguaranteed residual value Add: Initial direct cost Cost of sales

Total Sales

Add: Initial direct cost Cost of sales

Amortization Table 10% x PV

Payment – Interest

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413889810.doc Payment Jan. 1, 2005 Dec. 31, 2005 800,000 Dec. 31, 2006 800,000 Dec. 31, 2007 800,000 Dec. 31, 2008 800,000 Dec. 31, 2009 800,000

Page 16 of 19 Interest

Present value 3,156,820

315,682

484,318

2,672,502

267,250

532,750

2,139,752

213,975

586,025

1,553,727

155,373

644,627

909,100

90,910

709,090

200,000  (Bal) Res. Value

Guaranteed Jan.1, 2005

Principal

Unguaranteed

Initial Direct cost Cash Lease receivable Cost of sales Sales Unearned interest income Inventory Initial direct cost

Dec. 31, 2005 D Dec. 31, 2005

Cash Unearned interest income Lease receivable Interest income

When the lease expires on Dec. 31, 2009, the machinery will revert to the lessor. Guaranteed Unguaranteed Dec. 31, 2009 Inventory Lease receivable Assume, Dec. 31, 2009, FV of machinery is P150,000, the machinery will revert the lessor Guaranteed Unguaranteed Cash Inventory Loss on finance lease Lease receivable Exercise No. 6 – Sales Type Lease Excel Inc. leases equipment to its customer under noncancelable leases. On January 1, 2010, Excel leased equipment costing P4,000,000 to Microsoft Co., for nine years. The rental cost was P440,000 payable in advance semiannually (January 1 and July 1). The equipment had an estimated life of 15 years and sold for P5,330,252 with an estimated unguaranteed residual value of P800,000. The implicit interest rate is 12%. REQUIRED:

Prepare the 2010 journal entries relating to the lease on the books of Excel and Microsoft (Round off present value factors to four decimal places). Debit

Credit

LESSOR'S BOOKS January 1, 2010 Commencement of finance lease Finance lease receivable Cost of sales Sales Discount on FLR Inventory To record initial payment Cash Finance lease receivable July 1, 2010 To record the second payment Cash

8,720,000 3,719,012 5,050,012 3,389,748 4,000,000

440,000 440,000

440,000

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413889810.doc Finance lease receivable

Page 17 of 19 440,000

To record amortization of discount on FLR Discount on FLR Interest income

293,415 293,415

December 31, 2010 To record amortization of discount on FLR Discount on FLR Interest income

284,620 284,620

LESSEE'S BOOKS January 1, 2010 To recognize asset and liability Equipment under finance lease Finance lease liability

5,050,012 5,050,012

To record initial payment Finance lease liability Cash Amortization schedule (partial) lessor Date Payment 1/1/10 1/1/10 440,000 7/1/10 440,000 1/1/11 440,000 7/1/11 440,000 1/1/12 440,000

Amortization schedule (partial) lessee Date Payment 1/1/10 1/1/10 440,000 7/1/10 440,000 1/1/11 440,000 7/1/11 440,000 1/1/12 440,000

440,000 440,000

Interest

293,415 284,620 275,297 265,415

Interest

276,601 266,797 256,405 245,389

Principal 440,000 146,585 155,380 164,703 174,585

Principal 440,000 163,399 173,203 183,595 194,611

Carrying amount 5,330,252 4,890,252 4,743,667 4,588,287 4,423,584 4,248,999

Carrying amount 5,050,012 4,610,012 4,446,613 4,273,410 4,089,815 3,895,204

QUIZZER - FINANCE LEASE – LESSOR 1. Donna Company is a dealer in equipment. On January 1,2010, an equipment was leased to another entity with the following provisions: Annual rental payable at the end of each year P1,500,000 Lease term and useful life of machinery 5 years Cost of equipment 4,000,000 Residual value-unguaranteed 500,000 Implicit interest rate 12% PV of an ordinary annuity of 1 for 5 periods at 12% 3.60 PV of 1 for 5 periods at 12% 0.57 At the end of the lease term on December 31, 2014, the equipment will revert to the lessor, Donna Company. The perpetual inventory system is used. Donna Company incurred initial direct cost of P200,000 in finalizing the lease agreement. 1. What is the total financial revenue to be reported by Donna Company? a. P2,315,000 b. P1,815,000 c. P2,100,000 c. P2,600,000 2. What is the interest income to be recognized by Donna for 2010? a. P682,200 b. P648,000 c. P900,000 d. P960,000 3. What amount should Donna Company report as profit on the sale for 2010? a. P1,485,000 b. P1,685,000 c. P3,500,000 d. P4,000,000 2. Neliza Company uses leases as a method of selling its products. In 2010, Neliza Company completed construction of a passenger ferry. On January 1, 2010, the ferry was leased on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. Annual lease payments do not include executory costs. Other terms of the agreement are as folows: Original cost of the ferry P9,000,000 Lease payments payable in advance 2,000,000 Estimated residual value 1,000,000 Implicit interest rate 12% Date of first lease payment January 1, 2010 Lease term 10 years Present value of an annuity due of 1 at 12% for 10 periods 6.33 Present value of 1 at 12% for 10 periods 0.32 1. What is profit on sale for 2010?

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413889810.doc a. P3,980,000 b. P3,660,000 2. What is the interest income for 2010? a. P1,557,600 b. P1,317,600

Page 18 of 19 c. P7,340,000

d. P8,020,000

c. P1,279,200

d. P1,519,200

3. Carina Company is in the business of leasing new sophisticated equipment. As lessor, Carina Company expects a 12% return on its net investment. All leases are classified as direct financing lease. At the end of the lease term, the equipment will revert to Carina Company. On January 1, 2010, an equipment is leased to a lessee with the following information. Cost of equipment to Carina Company P5,250,000 Residual value – unguaranteed 600,000 Annual rental payable in advance 900,000 Useful life and lease term 8 years Implicit interest rate 12% First lease payment January 1, 2010 1. What is the unearned interest income on January 1, 2010? a. P2,550,000 b. P1,950,000 c. P3,150,000

d. P1,500,000

2. What is the interest income that should be recognized for 2010? a. P594,000 b. P522,000 c. P630,000

d. P450,000

4. Rissa Company acquired an asset costing P3,165,000. The asset is leased on January 1, 2010 to another entity. Five annual lease payments are due each December 31, beginning December 31, 2010. The unguarantedd residual value of the asset at the end of the lease term on December 31, 2014 is P500,000. The asset will revert to Rissa Company at the end of the lease term. The lessor’s implicit interest rate is 12%. The PV of 1 at 12% for 5 periods is .57 and the PV of an ordinary annuity of 1 at 12% for 5 periods is 3.60. What is the annual rental payment? a. P879,166 b. P740,278 c. P800,000 d. P500,000 5. Irene Company decided to enter the leasing business. The entity acquired a specialized packaging machine for P2,300,000. On January 1, 2010, Irene Company leased the machine for a period of six years, after which title to the machine is transferred to the lessee. The six annual lease payments are due each January 1 and the first payment was made on January 1, 2010. The residual value of the machine is P200,000. The lease terms are arranged so that a return of 12% is earned by Irene Company. The present value of 1 at 12% for six periods is 0.51, and the present value of an annuity in advance of 1 at 12% for six periods is 4.60. What is the annual lease payment payable in advance required to yield the desired return? a. P500,000 b. P477,826 c. P383,333 d. P460,000 Exercise No. 7 – Sales Leaseback (Finance) On January 1, 2009, Legend Company sold machinery costing P411,750 at the fair market value and then immediately leased the machine back for P150,000 annually, payable in advance. The life of the machinery and the lease term is five years. The implicit rate 12%. Assume that the fair market value and the present value of the lease payments are equal. REQUIRED: Compute the following – (a) Selling price of the machinery. (b) Deferred gain recorded on January 1, 2009. (c) Depreciation expense for the leased asset for the year 2009, assuming a straight-line method of depreciation. (d) Interest expense for the year 2009. (e) Gain on sale-leaseback for the year 2009. Exercise No. 8 – Sales Leaseback (Operating) On July 1, 2009, Honest Company sold equipment to Excellent Company, and simultaneously leased it back for 4 years. Pertinent information at this date is as follows: Sales price (equal to its fair value) – P540,000; Cost of equipment – P800,000; Accumulated depreciation – P350,000; Retaining economic life – 10 years; Annual lease payments payable in advance at the beginning of each lease year – P80,000; Implicit interest rate – 12%. REQUIRED: (a) Prepare all journal entries required in the books of Honest Company for the year 2009 to reflect the sale and leaseback transaction. (b) Assuming that the fair value of the asset on July 1, 2009 is P500,000, prepare all journal entries required in the books of Honest Company for the year 2009 to reflect the sale and leaseback transaction. (c) Assume, instead, that the sales price is P400,000. The rental of P80,000 is considered to be a fair annual rental. Prepare entries for 2009. (d) Assume, instead that the sales price is P350,000 and Honest able to bargain the annual rental of P80,000 although similar assets are being leased at an annual rental of P120,000. Prepare entries for 2009. (Honest Company)

(a) 2009 July 1

1 Dec. 31

Cash Accumulated Depreciation Equipment Gain on Sale Leaseback

540,000 350,000 800,000 90,000

Rent Expense Cash

80,000

Prepaid Rent Rent Expense

40,000

80,000 40,000

(b)

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413889810.doc 2009 July 1 Cash (d) Accumulated Depreciation 2009 Equipment July 1 Cash Gain on Sale Leaseback Accumulated Depreciation Unearned Profit on Sale Leaseback Deferred Loss on Sale Leaseback 1 Rent Equipment Expense Cash 1 Rent Expense Cash Dec. 31 Prepaid Rent Rent Expense Dec. 31 Prepaid Rent Rent Profit Expense 31 Unearned on Sale Leaseback Profit on Sale Leaseback Rent(40,000/4) Expense x 6/12 Deferred Loss on Sale Leaseback (c) 100,000 x 6/48 = 12,500 2009 July 1 Cash Accumulated Depreciation Loss on Sale Leaseback Equipment 1. and

1 Dec. 31

Page 19 of 19 540,000 350,000 350,000 100,000 80,000 80,000 40,000 40,000 5,000

800,000 50,000 40,000 800,000 80,000 80,000 40,000 40,000 5,000

12,500

12,500 400,000 350,000 50,000

QUIZZER LEASEBACK 800,000

Rent Expense Cash

80,000

Prepaid Rent Rent Expense

40,000

80,000 40,000

On December 31, 2010, Carmedia Company sold machine to another entity simultaneously leased it back for one year. Pertinent information at

this date follows: Sales price Carrying amount Present value of reasonable lease rentals (P30, 000 for 12 months @ 12%) Estimated remaining useful life

P3,600,000 3,300,000 341,000 12 years

In Carmedia Company’s 2010 income statement, what amount of revenue from sale of this machine should be reported? a. P341,000 b. P300,000 c. P41,000 d. 0 2. On December 31, 2010, Geraldine Company sold an equipment with an estimated remaining useful life of 10 years. At the same time, Geraldine Company leased back the equipment for 2 years. The leaseback is an operating lease. Sales price P7,500,000 Carrying amount 5,000,000 Fair value of equipment on date of sale 6,000,000 What amount of gain should Geraldine Company report in its 2010 income statement? a. P2,500,000 b. P1,500,000 c. P1,000,000 d. P1,750,000 3. On January 1, 2010, Lorene Company sold a machinery to another entity. Lorene Company leased back the machinery for 12 years for its use in the new farm that it is developing. The annual lease payment is P700, 000 on January 1 of each year. The sales price of the machinery was P5, 000,000 while the carrying amount as of the date of the sale was P3, 500,000. The engineers have estimated that the remaining economic life of the equipment is 15 years. Lorene Company is a wholly owned subsidiary of a US company. It is required to follow US GAAP in its reporting package for consolidation. In its reporting package for use in consolidation with the US parent company, what should Lorene Company report respectively as gain from sale of the equipment for 2010 and total finance cost over the lease term? a. P1,500,000 and P3,400,000 c. P1,500,000 and P4,900,000 b. P100,000 and P3,400,000 d. P125,000 and P3,400,000 4. On January 1, 2010, Dominique Company sold equipment it had recently purchased to an unaffiliated entity for P5, 700,000. The equipment had a carrying amount of P4, 500,000 and a remaining life of five years. On that same day, Dominique Company leased the equipment at P1, 350,000 per year payable in advance for a 5-year period. The lessor’s implicit interest rate in the lease is 10%. Dominique Company uses the double declining balance method of depreciation. What is the unearned income on the sale and leaseback on December 31, 2010? a. P1,200,000 b. P960,000 c. P720,000 d. 0

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