ST. THOMAS MORE COLLEGE – CLARK TMC Building, New York St.

Villa Sol Subdivision

  Angeles City, Philippines
A Professional Business School
Tel. No. (045) 321 - 0727
   
FINANCIAL ACCOUNTING AND REPORTING
Exercises on Leases

FINANCE LEASE - LESSEE

1. In connection with your review of Jonli Enterprises, you noted that the company has a long
standing policy of acquiring company equipment by leasing. Early in 2011, the company entered
into a lease for a new milling machine. The lease stipulates the 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, Jonli may purchase the machine. The estimated economic life of the equipment is
12 years. Jonli 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 P 10,000) P 120,000

Purchase option price 50,000
Estimated fair market value of machine after 5 years 150,000
Implicit rate 10%
Date of first lease payment January 2, 2012

***Questions: Based on the foregoing and the result of your audit, compute for the following:
(Round off present value factors to four decimal places.)
A. Amount to be capitalized as an asset for the lease of the milling machine:
a. 382,835 b. 489,734 c. 458,689 d. 508,689

B. Liability under finance lease as of December 31, 2012:

a. 261,838 b. 307,707 c. 273,560 d. 379,736

C. Amount to be reported under current portion of the finance lease as of December 31, 2012:
a. 72,026 b. 82,644 c. P 79,230 d. 83,816

D. Interest expense for the year 2012:

a. 0 b. 34,870 c. 33,804 d. 37,793

E. Depreciation expense for the year 2012:

a. 37,336 b. 40,811 c. 38,224 d. 97,948

OPERATING LEASE – LESSOR

2. Wall Company leased office premises to Fox Company for five-year term beginning January 1,
2013. Under the terms of the operating lease, rent for the first year is P800,000 and rent for years
2 through 5 is P1,250,000 per annum. However, as an inducement to enter the lease, Wall granted
Fox the first six months of the lease rent-free. What amount should Wall report as rental income
for 2013?
a. 1,200,000 b. 1,160,000 c. 1,080,000 d. 800,000

FINANCE LEASE – LESSOR

DIRECT FINANCING LEASE
For items no. 3-4, Camia Company is in the business of leasing new sophisticated equipment. As
lessor, the entity expects a 12% return. At the end of the lease term, the equipment will revert to Camia
Company. On January 01, 2013, an equipment is leased to another entity under a direct financing
lease.
Cost of equipment to Camia 5,500,000
Residual value - unguaranteed 400,000
Annual rental payable in advance 959,000
Useful life and lease term 8 years
Implicit interest rate 12%
First lease payment January 01, 2013

3. What is the unearned interest income on January 1, 2013?

a. 2,576,000 b. 2,176,000 c. 1,776,000 d. 1,616,500

Solution:
Gross rentals (959,500 x 8) 7,676,000
Residual value 400,000

Page 1 of 4
 ST. THOMAS MORE COLLEGE – CLARK TMC Building, New York St.
Villa Sol Subdivision
  Angeles City, Philippines
A Professional Business School
Tel. No. (045) 321 - 0727
   
Gross investment 8,076,000
Net investment - equal to the cost of the equipment 5,500,000
Unearned interest income - January 1, 2013 2,576,000

4. What is the interest income for 2013?

a. 322,000 b. 544,860 c. 660,000 d. 496,860

Solution:
Present value of rentals - equal to the cost of the equipment or net investment 5,500,000
First payment on January 1, 2013 (all principal payments) 959,000
Lease receivable - January 1, 2013 4,540,000
Interest income for 2013 (4,540,000 x 12%) 544,860

5. On January 1, 2013, Lessor Company leased a machine to Lessee Company. The machine had an
original cost of P6,000,000. The lease term was five years and the implicit internst rate on the
leases 15%. The lease is properly classified as a direct financing lease. The annual payments of
P1,730,541 are made each December 31. The machine reverts to Lessor at the end of the lease
term, at which time the residual value of the machine will be P400,000. The residual value is
unguaranteed.

The PV of 1 at 15% for 5 periods is .4972, and the PV of an ordinary annuity of 1 at 15% for 5
periods is 3.3522. At the commencement the lease, what would be the lease receivable on the part
of the lessor and lease liability on the part of the lessee?
Lease receivable Lease liability Lease receivable Lease liability
a. 6,000,000 6,000,000 c. 6,000,000 5,801,120
b. 5,801,120 5,801,120 d. 5,801,000 6,000,000

Solution:
Lessor
PV of lease payments (1,730,541 x 3.3522) 5,801,120
Unguaranteed residual value (400,000 x .4972) 198,880
Lease receivable equal to the cost of asset 6,000,000

Gross lease payments (1,730,541 x 5) 8,652,705

Unguaranteed residual value 400,000
Gross investment 9,052,705
Net investment (Cost f asset) 6,000,000
Unearned interest income 3,052,705

Lessee
Lease liability (1,730,541 x 3.3522) 5,801,120

SALES TYPE LEASE

For items no.6-8, Reagan Company used leases as a method of selling products. In 2013, the entity
completed construction of a passenger ferry. On January 1, 2013, the ferry was leased to the Super
Ferry Line 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 follows:

Original cost of the ferry 8,000,000
Fair value of ferry lease date 12,555,000
Lease payments payable in advance 1,500,000
Estimated residual value 2,000,000
Implicit interest rate 12%
Date of first lease payment January 1, 2013
Lease term 20 years
Present value of an annuity due of 1 at 10% for 20 periods 8.37
Present value of 1 at 12% for 20 periods 0.10

6. What is the unearned interest income on January 1, 2013?

a. 17,445,000 b. 19,245,000 c. 19,445,000 d. 22,000,000

Page 2 of 4
 ST. THOMAS MORE COLLEGE – CLARK TMC Building, New York St.
Villa Sol Subdivision
  Angeles City, Philippines
A Professional Business School
Tel. No. (045) 321 - 0727
   
Solution:
Gross rentals (1,500,000 x 20) 30,000,000
Present value or fair value of asset (1,500,000 x 8.37) 12,555,000
Unearned interest income - January 1, 2013 17,445,000

7. What is the gross profit on sale for 2013?

a. 6,555,000 b. 4,555,000 c. 4,755,000 d. 4,355,000

Solution:
Fair value of asset - sales revenue 12,555,000
Cost of sales 8,000,000
Gross profit on sale 4,555,000

8. What is the interest income for 2013?

a. 1,506,600 b. 1,524,600 c. 1,326,600 d. 1,350,000

Solution:
PV of rentals equal to the fair value of asset 12,555,000
Payment on January 1, 2013 - all applicable to principal 1,500,000
Lease receivable - January 1, 2013 11,055,000
Interest income for 2013 (11,055,000 x 12%) 1,326,600

9. Meg Company leased equipment from Wee Company on July 1, 2013 for an eight-year period
expiring June 30, 2021. Equal payments under lease are P600,000 and are due on July 1 of each
year. The first payment was made on July 1, 2013. The rate of interest contemplated by Meg and
Wee is 10%. The cash selling price of the equipment is P3,520,000 and the carrying amount is
P2,800,000. The lease is approximately recorded as a sales type lease. What amount of profile on
the sale and interest revenue should be recorded for the year ended December 31, 2013?
Profit on Sale Interest revenue Profit on Sale Interest revenue
a. 720,000 176,000 c. 45,000 176,000
b. 720,000 146,000 d. 45,000 146,000

Cash selling price 3,520,000

Cost of equipment sold 2,800,000
Profit on sale 720,000

Lease receivable - July 1, 2013 (cash selling price) 3,520,000

Less: First payment on July 1, 2013 (all applicable to principal) 600,000
Lease receivable - July 1, 2013 2,920,000

Interest revenue form July 1, 2013 to June 30, 2014

(2,920,000 x 10%) 292,000

Interest revenue form July 1, 2013 to December 31, 2013

(292,000 x 6/12) 146,000

10. Hitech Company, a dealer in machinery and equipment, leased equipment to Quality Company on
July 1, 2013. The lease is appropriately accounted for as a sale by Hitech and as a purchase by
Quality. The lease is for a ten-year period equal to the useful life of the asset expiring June 30,
2023. The first of ten equal annual payments of P250,000 was made on July 1, 2013. Hitch had
purchased the equipment for P1,337,500 on January 1, 2013, and established a list selling price of
P1,687,500 on the equipment. The present value on July 1, 2013 of the rent payments over the
lease term discounted at 12% was P1,582,500. What amount of profit on sale and interest income
should be recorded for the year ended December 31, 2013, respectively?
a. 245,000 and 94,950 c. 350,000 and 79,950
b. 245,000 and 79,950 d. 350,000 and 94,950

Solution:
Present value of rentals - Sales revenue 1,582,500
Cost of equipment 1,337,500
Profit on sale 245,000

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 ST. THOMAS MORE COLLEGE – CLARK TMC Building, New York St.
Villa Sol Subdivision
  Angeles City, Philippines
A Professional Business School
Tel. No. (045) 321 - 0727
   
Present value - July 1, 2013 1,582,500
Payment on July 1, 2013, all applicable to principal ( 250,000)
Lease receivable - July 1, 2013 1,332,500

Interest income form July 1, 2013 to June 30, 2014

(12% x 1,332,500) 159,900

Interest income from July 1, 2013 to December 31, 2013

(159,900 x 6/12) 79,950

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