LESSOR ACCOUNTING
A lessor shall classify either:
Operating lease
does not transfer substantially all the risks and rewards incidental to ownership of an
underlying asset
Finance lease
Any of the following situation:
The lease transfers ownership of the underlying asset to the lessee at the end
of the lease term.
The lessee has an option to purchase the asset at a price which is expected to
be sufficiently lower than the fair value at the date the options becomes
exercisable. ( option to purchase must be reasonably exercisable at the
inception of the lease)
The lease term is for the major part of the economic life of the underlying asset
even if the title is not transferred.
USA GAAP major part means at least 75 % of the economic life of
an asset.
The present value of the lease payments amounts to substantially all of the
fair value of the underlying asset at the inception of the lease.
USA GAAP substantially all means at least 90 % of the fair value of
the leased asset.
Other criteria:
The underlying asset is of such specialized nature that only the lessee can use
it without major modification.
If the lessee can cancel the lease, the lessor’s losses associated with the
cancelation borne by the lessee.
Gains or losses from the fluctuation in the fair value of the residual accrue to
the lessee.
The lessee has the ability to continue the lease for a secondary period at a
rent that is substantially lower than market rate.
OPERATING LEASE-LESSOR
Periodic rental received
recognized as rent income
Initial direct cost
Added to the carrying amount of the underlying asset and recognized as an
expense over the lease term on the same basis as the lease income.
Security deposit refundable upon the lease expiration shall be accounted for as liability
by the lessor.
Lease bonus received by the lessor from the lessee is recognized as unearned rent
income to be amortized over the lease term.
The underlying asset remains as an asset of the lessor. The lessor bears all ownership or
executory cost.
Unequal rental payments
The total cash payments for the lease term shall be amortized uniformly on the
straight line basis as rent income over the lease term.
FINANCE LEASE-LESSOR
Direct financing lease
Sales type lease
DIRECT FINANCING LEASE
Sources of income: interest income
GROSS INVESTMENT (Lease receivable) XXXX
Gross rentals for the entire lease
term
Absolute amount of the residual value whether guaranteed or not
(if the asset will not revert or there is a transfer of title, the residual
value is completely ignored)
NET INVESTMENT (asset) (xxxx)
Cost of the
asset
Initial direct cost paid by the lessor
UNEARNED INTEREST INCOME XXXX
The lessor shall recognize finance income over the lease term based on a pattern reflecting a
constant periodic rate of return on the lessor’s net investment in the lease.
The lessors shall recognize assets held under a finance lease as a receivable at an amount equal
to the net investment in the lease.
JOURNAL ENTRIES:
At the inception of the lease term
DR. Lease receivable xxxx
CR. Asset xxxx
Unearned interest income xxxx
DR Asset xxxx
CR Cash xxxx
Initial Direct cost
Annual Collection
DR. Cash xxxx
CR. Lease receivable xxxx
DR. Unearned Interest Income xxxx
CR. Interest Income xxxx
When the lease expires
DR Asset xxxx
CR Lease receivable xxxx
Fair value of the asset is lower than the residual value
Guaranteed residual value
DR. Cash xxxx
Asset xxxx
CR Lease receivable xxxx
Unguaranteed residual value
DR. Loss on finance lease xxxx
Asset xxxx
CR Lease receivable xxxx
SALES TYPE LEASE-LESSOR
Sources of income: Interest income and gross profit
GROSS INVESTMENT (the same in direct finance lease) XXXX
Gross rentals for the entire lease term
Absolute amount of the residual value whether guaranteed or not
(It should be reverted, if will not revert completely
ignored)
NET INVESTMENT (xxxx)
Present value of the gross rentals
Present value of the residual value whether guaranteed or not
UNEARNED INTEREST INCOME XXXX
SALES xxxx
Whichever is lower:
Net investment in the
lease
Fair value of the asset
COST OF GOODS SOLD (xxxx)
Cost of the asset
Initial direct cost paid by the lessor
GROSS PROFIT XXXX
Initial direct cost is expensed immediately as component of cost of goods sold.
UNGUARANTEED RESIDUAL VALUE
The present value of the unguaranteed residual value is not included in the sales
revenue.
The present value of the unguaranteed residual value is deducted from the cost of
the underlying asset in computing cost of goods sold.
The lease receivable and unearned interest income are the same whether the
scenario is guaranteed or unguaranteed residual value.
ACTUAL SALE OF UNDERLYING ASSET
Sales price XXXX
Carrying amount of lease receivable (XXXX)
PROFIT/LOSS XXXX
Carrying amount of receivable is equal to the balance of the lease receivable minus the
unearned interest income.
SAMPLE PROBLEMS
PROBLEM 1
LIGAYA Company purchased a tractor on January 01, 2017 at a cost of P 1,500,000 for the purpose of
leasing it.
The tractor is estimated to have a useful life of 5 years with residual value of P 100,000. Depreciation is
on a straight line basis.
On April 01, 2017, Ligaya entered into a lease contract for the lease of the tractor for a term of two
years up to March 31, 2019.
The lease fee is P 50,000 monthly and the lessee paid P 600,000, the lease fee for one year.
LIGAYA paid P 120,000 commission associated with negotiating the lease, P 15,000 minor repairs and P
10,000 transportation of the tractor to the lessee during the current year.
What amount of net rent revenue should be reported for the current year 2017?
SOLUTION
Lease term 2 years
Useful life 5 years
40%, at least 75% of economic life of the asset to be a finance lease
Operating lease
Rent revenue - April to December 2017 (600000 x 9/12) 450,000.00
LESS: Depreciation expense ((1,500,000-100,000)/5) 280,000.00
Commission ((120,000/2) x 9/12) 45,000.00
Repairs 15,000.00
Transportation 10,000.00
NET RENT REVENUE 100,000.00
PROBLEM 2
MAAN Company leased office premises to AYA Inc. for a 5-year term beginning January 2, 2017. Under
the terms of the operating lease, rent for the first year is P 150,000 and rent for years 2 through 5 is P
187,500 per annum. However, as an inducement to enter the lease, MAAN granted AYA the first 6
months of the lease rent-free and provided an allowance of P 8,000 as an additional incentive.
In its December 31, 2017 income statement, what amount should MAAN report as rental income?
SOLUTION:
Cash rent for 2017 (150,000 X 1/2) 75,000.00
Cash rent for 2018 to 2021 (187,500 x 4) 750,000.00
TOTAL CASH RENT 825,000.00
-
LESS: Cash incentive provided 8,000.00
Adjusted total cah rent for 5 years 817,000.00
DIVIDED BY: lease term 5 years
ANNUAL RENT INCOME 163,400.00
PROBLEM 3
ECZEL Company is engaged in leasing equipment. As a lessor of equipment, EZCEL purchased a new
equipment on December 31, 2017. The equipment was delivered the same day to the lessee under a
direct financing lease with the following provisions:
Cost of Equipment 550,000.00
Estimated useful life and lease term 8 years
Expected residual value - unguaranteed 40,000.00
Implicit rate of interest 12%
Incremental borrowing rate 14%
Date of first lease payment Dec. 31, 2017
Additional information as follows:
a. At the end of the lease, the system will revert to ECZEL.
b. Lessee is aware of ECZEL’s rate of implicit interest.
c. The lease rental consists of equal annual payments.
QUESTIONS:
1. At the commencement of the lease, what would be the net lease receivable on the part of the lessor?
2. What is the gross investment in the lease?
3. What is the total unearned interest income?
4. What is the interest for the year 2018?
SOLUTION
1. Net lease receivable is equal to the cost of the asset P 550,000.00
2.
Cost of the asset 550,000.00
LESS: PV of unguaranteed residual value (40000 x 0.4039) - 16,156.00
Net investment/lease receivable to be recovered 533,844.00
DIVIDED BY: PV of annuity due of 1 at 12% for 8 periods 5.56
Annual lease payment 95,949.53
Lease term 8 years
Total lease payments 767,596.25
Unguaranteed residual value 40,000.00
GROSS INVESTMENT 807,596.25
3.
Cost of the asset 550,000.00
LESS: PV of unguaranteed residual value (40000 x 0.4039) - 16,156.00
Net investment/lease receivable to be recovered 533,844.00
DIVIDED BY: PV of annuity due of 1 at 12% for 8 periods 5.56
Annual lease payment 95,949.53
Lease term 8 years
Total lease payments 767,596.25
Unguaranteed residual value 40,000.00
GROSS INVESTMENT 807,596.25
Net investment/lease receivable to be recovered 550,000.00
TOTAL UNEARNED INTEREST INCOME 257,596.25
4.
Net investment - 12/31/2017 550,000.00
Lease payment - 95,949.53
Carrying amount of lease receivable - 12/31/2017 454,050.47
Implicit interest rate 12%
Interest income 2018 54,486.06
PROBLEM 4
RED Company is in the business of leasing new sophisticated equipment. Such an equipment was
delivered to a lessee on January 1, 2017 under a direct financing lease with the following provisions:
Cost of equipment 3,390,000.00
Annual rental payable at the end of each year 600,000.00
Estimated useful life and lease term 10 years
Implicit rate of interest 12%
PV of an ordinary annuity of 1 at 12% for 10 periods 5.65
The entity incurred and paid initial direct cost of P 143,400.00 in negotiating and arranging the lease.
The equipment will revert to RED company at the end of the lease.
REQUIREMENTS:
1. Compute the total financial revenue to be recognized over the lease term.
2. Determine the new implicit interest rate that will be used in computing interest income.
3. Journal entries on the books of RED Company for 2017.
SOLUTION:
1.
GROSS INVESTMENT
Annual rent payable (600,000 x 10) 6,000,000.00
NET INVESTMENT
Cost of equipment 3,390,000.00
Initial Direct cost 143,400.00 3,533,400.00
TOTAL FINANCIAL REVENUE 2,466,600.00
2. 11%
Annual rent payable 600,000.00
PV of an ordinary annuity of 1 at 11% for 10 periods 5.89
Net investment 3,533,400.00
3.
DR Equipment 143,400.00
CR Cash 143,400.00
DR Lease receivable 6,000,000.00
CR Equipment 3,533,400.00
Unearned interest income 2,466,600.00
DR Cash 600,000.00
CR Lease Receivable 600,000.00
DR Unearned interest income 388,674.00
CR Interest income 388,674.00
PROBLEM 5
DREAMS Company decided to enter the leasing business. The entity acquired a specialized packaging
machine for P 2,300,000.00.
On January 1, 2017, the entity 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,
2017. The residual value of the machine is P 200,000.00.
The lease term are arranged so that a return of 12% is earned by DREAMS Company.
What is the annual lease rental payable in advance required to yield the desired return?
SOLUTION:
Cost of the machinery to be recovered from rental 2,300,000.00
PV of an annuity due of 1 at 12% for 6 periods 4.60
Annual rental 500,000.00
If the machinery will not revert to the lessor at the end of the lease term, the residual
value is completely ignored in the computation of the annual rental and unearned interest
income.
PROBLEM 6
MOD Company used leases as a method of selling its products. In early 2017, DOM completed
construction of a passenger ferry for use between Mindoro and Batangas. On April 01, 2017, the ferry
was leased to the JULIENNE Ferry Line on a contract specifying that ownership of the ferry will transfer
to the lessee at the end of the lease period. The ferry is expected to be economically useful for 25 years.
Annual lease payments do not include executory costs. Other terms of the agreement are as follows:
Original cost of the ferry 1,500,000.00
Lease payments 225,000.00
Estimated residual value 78,000.00
Implicit rate of interest 10%
Date of first lease payment April 01, 2017
Lease period 20 years
PV of an ordinary annuity of 1 at 10% for 20 periods 8.5136
PV of an annuity due of 1 at 10% for 20 periods 9.3649
PV of 1 at 10% for 20 periods 0.1486
QUESTIONS:
1. Total finance income that will be earned by the lessor over the lease term.
2. The profit on sale to be recognized by the lessor.
3. Liability under finance lease to be reported by the lessee as of December 31, 2018.
4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of
December 31, 2018.
5. Depreciation expense to be recognized by the lessee for the year 2017.
SOLUTION:
1.
Gross investment in the lease ( 225,000 x 20) 4,500,000.00
Net investment in the lease ( 225,000 x 9.3649) 2,107,102.50
TOTAL FINANCE INCOME 2,392,897.50
2.
Sales - present value of minimum lease payments 2,107,102.50
Cost of sales - cost of the ferry 1,500,000.00
PROFIT ON SALE 607,102.50
3.
Finance lease liability - 04/01/2017 2,107,102.50
LESS: Lease payment, 04/01/2017 - 225,000.00
Carrying amount - 04/01/2017 1,882,102.50
LESS: Principal Lease payment, 04/01/2018
Total payment - 04/01/2018 225,000.00
Less: Interest income 188,210.00 36,790.00
Carrying amount - 04/01/2018 1,845,312.50
4.
Rental payment 225,000.00
Interest income (1,845,312.50 x .10) 184,531.25
CURRENT PORTION OF LEASE LIABILITY 40,468.75
5.
Depreciation Expense [(2,107,103 - 78,000) x 1/25 x 9/12) 60,873.00
PROBLEM 7 uberita
BERT Company manufactures, sells and leases heavy construction equipment, leased equipment to
ANGEL Company, a regular customer, on January 1, 2017. Costs to manufacture the leased equipment is
P 1,008,000. The lease payments are P 252,644 beginning on January 01, 2017 and continuing annually
with the last payment being made on January 01, 2021. If ANGEL were to purchase the equipment
outright the fair market value would be P 1,167,524. Because of the heavy wear expected on the
equipment, the lease contains a residual value clause on December 30, 2021, of P 260,000. Angel
contracted with AB Finance to serve as a third party guarantor of the residual value. BERT implicit rate
known to ANGEL is 12%, which is lower than ANGEL’s borrowing rate of 14%. Expected useful life of the
equipment is 10 years.
1. What is the amount of gross profit on sale that Bert should report in year 2017? 159,343.83
2. How much is the adjusted cost of sales attributed to the lessee? 860,580
SOLUTION:
PV of annual rental payment (252,644 x 4.04) 1,019,923.83
PV of residual value (260,000 x .567) 147,420.00
Net investment - SALES 1,167,343.83
Fair market value of the underlying asset 1,167,524.00
Sales price 1,019,923.83
Cost of sales
Cost of asset 1008000
PV of residual value (260,000 x .567) 147,420.00 860,580.00
GROSS PROFIT 159,343.83
PROBLEM 8
PINK Company leased equipment to BLACK Corp. on January 1, 2017 for an 8-year period expiring
December 31, 2024. Equal payments under the lease are P 600,000 and are due on December 31 of each
year. The first payment was made on December 31, 2017. The rate of interest contemplated by PINK
and black is 11%. The present value of the equipment is P 3,087,674. PINK Company incurred a total
transaction costs of P 44,544 to negotiate the contact of lease. If the transaction cost is included the
effective yield is 10.6%
1. If the lease is accounted as a sales type lease, what is the initial carrying value of the lease receivable
on January 01, 2017? 3,087,674
2. If the lease is accounted as a sales type lease, what is the carrying value of the lease receivable on
December 01, 2017? 2,827,318.14
3. If the lease is accounted as a sales type lease, what amount of finance income should the lessor
report in its 2017 profit or loss? 339,644.14
4. If the lease is accounted as a direct financing lease, what amount of finance income should the lessor
report in its 2017 profit or loss? 332,015
SOLUTION:
Interest
Date Payment 11% Principal Present Value
01/01/2017 3,087,674
12/31/2017 600,000.00 339,644.14 260,355.86 2,827,318.14
12/31/2018 600,000.00 311,005.00 288,995.00 2,538,323.14
12/31/2019 600,000.00 279,215.54 320,784.46 2,217,538.68
Interest
Date Payment 10.60% Principal Present Value
01/01/2017 3,132,218
12/31/2017 600,000.00 332,015.11 267,984.89 2,864,233.11
12/31/2018 600,000.00 303,608.71 296,391.29 2,567,841.82
