ADVANCED TOPICS IN FINANCIAL ACCOUNTING AND REPORTING (MODADV3)

UNIT 4 LEASES (IAS 17, IFRS 16, IFRIC 4, SIC 27, SIC 15)
ESTIMATED TIME: 4.0 HOURS

Problem 1 Operating lease lessee and lessor

On January 1, 20A1, Sweetwater Furniture Company leased a commercial space from Coolwater
Company under a 5-year operating lease agreement. Previously, Sweetwater issued a commercial
space from another location. As an incentive for relocating into Coolwaters commercial building,
Coolwater agreed to pay Sweetwater moving costs of P50,000 and to provide 3 months free rent. The
new lease contract calls for annual rent payments as follows:
P150,000 for the first year, which increases by P15,000 per year, this is payable in advance
every January 1 of each year.
10% of sales in excess of P2,000,000 payable every January 31 of the subsequent year.
In addition, the contract states that Sweetwater is required to pay a security deposit of P300,000 on
January 1, 20A1. Benefits expected from using the office space are expected to remain constant over
the lease term.

Actual sales of Sweetwater for the first three year of the contract are as follows:
For the year ended December 31, 20A1 P1,700,000
For the year ended December 31, 20A2 P3,000,000
For the year ended December 31, 20A3 P5,000,000
Ignore the effects of time value of money.
Required:
1. Prepare the necessary journal entries for 20A1 and 20A2.
2. Prepare a schedule of future minimum lease payments for 20A1 and 20A2 for purposes of financial
statements disclosures for both Sweetwater and Coolwater.

Problem 2 Direct finance lease; sales-type lease; lessee and lessor

Kimbrell, Inc. manufactures certain equipment. Emerald Leasing Company purchased an equipment
from Kimbrell for P3,000,000 and leased the same to Garnet, Inc. on January 1, 20A1 The following
are the terms of the lease:
Quarterly rental payments P179,873; payable at the beginning of the period
Lease term 5 years
Economic life 5 years
The lease agreement does not provide an option on the part of Garnet to purchase the equipment at
the end of the lease term. The implicit interest rate and Garnets incremental borrowing rate are the
same which is at 8%. The equipment had a fair value of P3,000,000 on January 1, 20A1, and there is
no residual value. Collectiblity of the rental payments is reasonably assured and there are no lessor
costs yet to be incurred.
Required:
1. How should the lease by classified by Emerald and by Garnet?
2. Prepare the necessary journal entries for Emerald and Garnet from the inception of the lease
through the second rental payment on April 1, 20A1. Depreciation is recorded at the end of every
quarter.
3. Assume that the lease agreement included a purchase option of P321,050 even though the
estimated value of the equipment at the end of the lease term is P500,000 and that the new implicit
rate is 10%. In addition, the economic life of the equipment is 8 years and the residual value at the
end of the economic life is P100,000.
a. Prepare the necessary journal entries for Emerald and Garnet from the inception of the lease
through the second rental payment on April 1, 20A1. Depreciation is recorded at the end of
every quarter.
b. Prepare the necessary journal entry to record the exercise of the bargain purchase option.
c. Prepare the necessary journal entry assuming the lessee did not exercise the option.
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4. Assume that Garnet leased the equipment directly from Kimbrell, the manufacturer (the cost of
Kimbrell is P2,200,000). In addition, the economic life of the equipment is 8 years.
a. Prepare the entries for Kimbrell and Garnet from the inception of the lease through the second
rental payment on April 1, 20A1.
b. How much is the dealers profit that Kimbrell would recognize in this lease?

Problem 3 Guaranteed residual value; direct finance lease; executory costs

On January 1, 20A1, Buttermilk Industries leased equipment to Apricot Co. The term of the lease is 8
years which will end December 31, 20A8. The ownership of the leased asset will revert back to
Buttermilk at the end of the lease term. Buttermilk purchased the equipment for P996,885 and has an
expected economic life of 12 years. Its normal sales price is P996,885. Apricot guaranteed that the
residual value of the leased asset at December 31, 20A1 is P250,00. Annual rental payments are due
on December 31 every year, except for the first payment which was made on January 1, 20A1.
Executory costs of P10,000 are advanced by Buttermilk on every lease payment. Collectability of the
remaining lease payments is reasonably assured, and Buttermilk has no material cost uncertainties.
Apricots incremental borrowing rate is 12%. Apricot knows that the interest rate implicit in the lease is
10%. Both companies use straight-line depreciation.
Required:
1. How should the lease be classified by Apricot and Buttermilk?
2. How much is the annual rental payments?
3. How much is the unearned interest income at the inception of the lease, before the first
payment?
4. How much is the unearned interest income as of December 31, 20A1?
5. How much is the lease receivable, net and lease payable, net as of January 1, 20A1 after the
first lease payment?
6. How much is the lease receivable, net and lease payable, net as of December 31, 20A1?
December 31, 20A2?
7. How much is the interest income and interest expense to be recognized by the lessor and
lessee, respectively for 20A1?
8. How much is the total expenses recognized by the lessee for 20A1?
9. Prepare the appropriate entries for both Apricot and Buttermilk on December 31, 20A8,
assuming the equipment is returned to Buttermilk and the actual residual value is P250,000.
10. Prepare the appropriate entries for both Apricot and Buttermilk on December 31, 20A8,
assuming the equipment is returned to Buttermilk and the actual residual value is P200,000.
11. Assume that a third party, unrelated to Apricot and Buttermilk, guaranteed the residual value of
P250,000. Said third party is financially capable of discharging the obligations under the
guarantee.
a. How should the lease be classified by Apricot and Buttermilk?
b. How much is the annual rental payments?
c. How much is the lease receivable, net and lease payable, net as of January 1, 20A1 after the
first lease payment?
d. How much is the lease receivable, net and lease payable, net as of December 31, 20A1?
December 31, 20A2?
e. How much is the interest income and interest expense to be recognized by the lessor and
lessee, respectively for 20A1?
f. How much is the total expenses recognized by the lessee for 20A1?
g. Prepare the appropriate entries for both Apricot and Buttermilk on December 31, 20A8,
assuming the equipment is returned to Buttermilk and the actual residual value is P250,000.
h. Prepare the appropriate entries for both Apricot and Buttermilk on December 31, 20A8,
assuming the equipment is returned to Buttermilk and the actual residual value is P200,000.

Problem 4 Initial direct cost; direct financing and sales-type lease

Watermelon Leasing purchased a single engine plane for P6,455,240 and immediately leased the
plane to Honeydew Flying Club on December 31, 20A1 for eight years. The terms of the lease
agreement and other related information are as follows:

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a. Annual payments of P1,100,000 beginning December 31, 20A1, the inception of the lease, and at
each December 31.
b. Costs of negotiating and consummating the completed lease transaction incurred by Watermelon
were P181,060.
c. Watermelons implicit rate was 10% before initial direct costs and 9% after adjusting for initial direct
costs. These rates are not known by the lessee. The estimated economic life of the plane is eight
years.
d. Honeydews incremental borrowing rate is 10%.
e. Collectability of the rent payments by Watermelon is reasonably predictable and there are no costs
to the lessor that are yet to be incurred.
Both companies use straight-line depreciation.
Required:
1. How should the lease be classified by Watermelon and Honeydew?
2. How much is the lease receivable, net as of December 31, 20A1? December 31, 20A2?
3. How much is the lease payable, net as of December 31, 20A1? December 31, 20A2?
4. Assume that Watermelon Leasing is a dealer of planes and acquired the plane for P4,000,000 and
leased it to Honeydew for its fair market value of P6,455,240 on December 31, 20A1.
a. How should the lease be classified by Watermelon Leasing?
b. How much is the dealers profit of Watermelon Leasing?

Problem 5 Sale and leaseback; finance lease

Pineapple Courier Corporation is in need of funds in order to finance its working capital requirement.
In connection, it sold its building to Apple Insurance Company on January 1, 20A1 for P5,000,000
(which is equal to its fair value) and immediately leased it back. The lease is for a 10-year period; at
which time ownership of the building will revert back to Pineapple. The building has a carrying amount
of P4,000,000. It was originally acquired for P10,000,000. The lease requires Pineapple to make
payments of P745,145 to Apple every December 31. The building had a total remaining economic life
of 10 years with no residual value. The implicit rate, which is known by the lessee, is 8%.
Required:
1. Prepare the entries on January 1, 20A1 and December 31, 20A1 in the books of the lessor and
the lessee.
2. Assuming that the building has a carrying amount of P5,500,000 immediately before the sale.
Prepare the entries for Pineapple and Apple on January 1, 20A1.

Problem 6 Sale and leaseback; operating lease

On January 1, 20A1, Verve Garden Company sold an office building with carrying amount of
P5,000,000 (cost of P8,000,000) to Vertex Tower, Inc. for P6,000,000 which is equivalent to its fair
market value. It has a remaining useful life of 20 years. Verve immediately leased the said building
from Vertex for 10 years. Annual rentals amount to P250,000 per year. The rentals are payable in
advance, every January 1 of each year. The first annual rental is payable on January 1, 20A1.

Required:
1. Prepare all the necessary journal entries for 20A1 in the books of Verve Garden and Vertex
Tower.
2. Assume that the building has a fair market value of P5,300,000. Prepare all the necessary
journal entries for 20A1 in the books of Verve Garden and Vertex Tower.
3. Assume that Verve Garden sold the office building for P4,200,000, although its fair value is
P5,300,000. Prepare all the necessary journal entries for 20A1 in the books of Verve Garden
and Vertex Tower.
4. Assume that Verve Garden sold the office building for P4,200,000, although its fair value is
P4,500,000. Prepare all the necessary journal entries for 20A1 in the books of Verve Garden
and Vertex Tower.
5. Assume that Verve Garden sold the office building for P4,200,000, although its fair value is
P5,300,000 and carrying value is P5,500,000 and charged annual rental of P250,000 which is
sufficiently lower than market rent. Prepare all the necessary journal entries for 20A1 in the
books of Verve Garden and Vertex Tower
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 IFRS 16 PROBLEMS

Problem 1 Lessee initial and subsequent measurement of right of use asset and lease liability.
Case A: On January 20A1, Everwing Company (lessor) entered into a contract with Mobile Legend
Company (lessee) that conveys the right to use an asset (office building) for a period of 5 years in
exchange for annual lease payments of P1,000,000 payable every January 1 of each year beginning
20A1. Mobile Legend Company paid the first lease payment due on January 1, 20A1, annual executory
costs of P35,000 and initial direct costs of P100,000.
On the same date, Everwing Company makes the underlying asset available for use by Mobile Legend
Company. Moreover, Mobile Legend Company received P350,000 worth of lease incentive from
Everwing Company. The building is expected to be economically usable by one or more users for a
period of 8 years from the commencement date of the lease. They also agreed that by the end of the
lease term, the ownership of the underlying asset will be transferred to Mobile Legend Company. The
contract also provides that Mobile Legend Company will have to restore the underlying asset to the
condition required by the terms and conditions of the lease. These costs were estimated to be at
P200,000. The implicit rate of the lease was 10% which is known to both parties.
Required:
1. Compute the carrying amount of the lease liability as of January 1, 20A1, the interest expense
on the lease liability for the year ended December 31, 20A1, and the carrying amount of the
lease liability as of December 31, 20A1.
2. Compute for the carrying amount of the right of use asset as of January 1, 20A1, depreciation
expense for the year ended December 31, 20A1 and the carrying amount of the right of use
asset as of December 31, 20A1.
3. Prepare all the necessary journal entries for 20A1.

Case B: Use the same scenario in Case A but assume that instead of the transfer of ownership,
Everwing Company agreed to a purchase option with an exercise price of P500,000 that is reasonably
certain to be exercised by Mobile Legend Company by the end of the lease term.
Required:
1. Compute the carrying amount of the lease liability as of January 1, 20A1, the interest expense
on the lease liability for the year ended December 31, 20A1, and the carrying amount of the
lease liability as of December 31, 20A1.
2. Compute for the carrying amount of the right of use asset as of January 1, 20A1, depreciation
expense for the year ended December 31, 20A1 and the carrying amount of the right of use
asset as of December 31, 20A1.

Case C: Use the same scenario in Case A but assume the asset will revert back to the lessor and an
amount of P500,000 is expected to be payable by Mobile Legend Company under residual value
guarantees.
Required:
1. Compute the carrying amount of the lease liability as of January 1, 20A1, the interest expense
on the lease liability for the year ended December 31, 20A1, and the carrying amount of the
lease liability as of December 31, 20A1.
2. Compute for the carrying amount of the right of use asset as of January 1, 20A1, depreciation
expense for the year ended December 31, 20A1 and the carrying amount of the right of use
asset as of December 31, 20A1.

Case D: Use the same scenario in Case A but assume the asset will revert back to the lessor and that
an amount of P500,000 is the estimated unguaranteed residual value (that portion of the residual value
of the underlying asset, the realization of which by a lessor is not assured or is guaranteed solely by
a party related to the lessor).
Required:
1. Compute the carrying amount of the lease liability as of January 1, 20A1, the interest expense
on the lease liability for the year ended December 31, 20A1, and the carrying amount of the
lease liability as of December 31, 20A1.

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2. Compute for the carrying amount of the right of use asset as of January 1, 20A1, depreciation
expense for the year ended December 31, 20A1 and the carrying amount of the right of use
asset as of December 31, 20A1.

Case E: Use the same scenario in Case A but assume that an amount of P500,000 represent
payments of penalties for terminating the lease and the lease term reflects the lessee exercising an
option to terminate the lease at the end of the fourth year. The dismantling cost at the end of the fourth
year is estimated at P150,000.
Required:
1. Compute the carrying amount of the lease liability as of January 1, 20A1, the interest expense
on the lease liability for the year ended December 31, 20A1, and the carrying amount of the
lease liability as of December 31, 20A1.
2. Compute for the carrying amount of the right of use asset as of January 1, 20A1, depreciation
expense for the year ended December 31, 20A1 and the carrying amount of the right of use
asset as of December 31, 20A1.

Problem 2 Variable lease payments at the beginning of the year.

On January 20A1, a lessee entered into a 5-year lease of property with annual lease payments of
P1,000,000 payable at the beginning of each year. The contract specifies that the lease payments will
increase every two years on the basis of the increase in consumer price index for the preceding 24
months. The consumer price index at the commencement date is 125. The rate implicit in the lease is
not readily determinable. Lessees incremental borrowing rate is 5% per annum, which reflects the
fixed rate at which lessee could borrow an amount similar to the value of the right-of-use asset, in the
same currency, for a five year term and with similar collateral.
At the beginning of 20A3 of the lease, the consumer price index is 135.
Required:
1. Compute for the value of the right of use asset and lease liability on initial recognition date and
prepare a compound entry.
2. Compute the interest expense for 20A3.
3. Compute the carrying amount of the lease liability account as of December 31, 20A3.
4. Compute the carrying amount of the right of use asset as of December 31, 20A13
5. Prepare all the journal entries in 20A3.

Problem 3 Sale and lease-back,

Case A: Apple company has an equipment acquired three years ago at a cost of P1,000,000 and with
a total estimated life of 10 years. On January 1, 20A1, the Apple Company entered into an exchange
transaction with Orange Company to transfer the equipment but didnt satisfy the requirements of IFRS
15 Revenue from Contracts with Customers. The transfer proceeds amounted to P850,000 while the
annual rental payable at the end of each year amounts to P140,000 with an incremental borrowing
rate of 10%.
Required: Prepare the entries to record the sale and lease-back transaction in the books of the
buyer-lessor and the seller-lessee.

Case B: Use the same scenario is Case A but assume that the exchange transaction entered into is
a sale transaction which satisfied the requirements of IFRS 15 Revenue from Contracts with
Customers and Apple immediately leased back the said property for the remaining life of the
property on the same date. Assume also that the transfer proceeds is at fair value.
Required: Prepare the entries to record the sale and lease-back transaction in the books of the
buyer-lessor and the seller-lessee.

Case C: Use the same scenario in Case B but assume that the fair value of the equipment is
P750,000.
Required: Prepare the entries to record the sale and lease-back transaction in the books of the
buyer-lessor and the seller-lessee.

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Case D. Use the same scenario in Case B but assume that the fair value of the equipment is
P900,000.
Required: Prepare the entries to record the sale and lease-back transaction in the books of the
buyer-lessor and the seller-lessee.

Case E. Use the same scenario in Case B but assume that the fair value and the sales price are
both worth P500,000 and the annual rentals amounted to P100,000.
Required: Prepare the entries to record the sale and lease-back transaction in the books of the
buyer-lessor and the seller-lessee.

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