Chapter 10 - Lessee Accounting

Tuesday, 7 November 2023 8:09 pm

Lease
o IAS 7 (old standard) → IFRS 16 (new standard)
LESSOR (Lr) LESSEE (Le)
→ allows the property (E/M/B) to be rented → the person paying rent to use the
property (E/M/B)

→ records the rent income → records the rent expense

→ has/ records/ depreciate the physical asset → receives the benefits from the asset =
income
→ provides the right to use an underlying asset → Recognize the Right of use asset (ROUA)
for a period of time in exchange for (INTANGIBLE ASSET)
consideration.
→ Recognize the lease liability

IFRS 16: 2 Models

OPERATING → Small value or shorter period
LEASE
FINANCE LEASE → Requisites:
a. There is a TRANSFER OF ASSET @ the end of lease term
b. Lease agreement is the MAJORITY LIFE of the asset (50 + 1)
c. If the lease liability is SIGNIFICANTLY EQUAL to the FV of asset
d. There is an OPTION to purchase lower than the residual value at the
end of lease term

Finance Lease [POV: Lessee (Le)]

ROUA - Initial a. PV of lease liability (always present)
measurement b. IDC - Initial direct cost
c. The value of dismantling
d. Lease bonus paid by the lessor
Lease liability - a. PV of lease liability (+ component of purchase option)
inclusion b. Fixed or variable lease payment
c. Termination cost
d. Residual value (only if guaranteed)
e. Exercise option

_____________________________________________________________________________________________

PROBLEMS

Illustration 1 - Transfer of title to lease (p. 330)

On January 1, 2020, an entity leased a machinery for 4 years with 12% implicit interest rate which is
the same as the useful life of the machinery at annual rent of 100,000 payable of the each year.
The lease provides for a transfer of ownership at the end lease term.

ROUA=LL ROUA 303,730

PV of 1 = 12% → 3.0373
100,000 x 3.0373
Lease Liability 303,730

Dep - ROUA Depreciation Expense - ROUA 75,933

303,730/4 = 75,932.5
Accumulated Depreciation 75,933

Intermediate Accounting 2 Page 1

 Accumulated Depreciation 75,933

Date LP Interest (12%) Principal CA

Jan-1-2020 - - - 303,730
Dec-31-2020 100,000 36,448 63,552 240,178
Dec-31-2021 100,000 28,821 71,179 168,999
Dec-31-2022 100,000 20,280 79,720 89,279
Dec-31-2023 100,000 10,721 89,279 -

Year 1 Interest Expense 36,448

Lease Liability 63,552
Cash 100,000
o Every year (4 x)

_____________________________________________________________________________________________

Illustration 2 - Certain Purchase Option (p. 332)

On January 1, 2020, Lessee Company leased a machine with the following pertinent information:

Rental payment at the end of each year 1,000,000

Lease term 10 years
Useful life of machine 12 years
Implicit interest rate 12%
Incremental borrowing rate 14%
Residual value of machine 600,000

Lessee Company had the option to purchase the machine upon the lease expiration on January
1, 2031 by paying P500,000.

The lessee is reasonably certain to exercise the purchase option at the commencement date of
the lease.

Note:
o If 2 term is given:
1ST PRIORITY: Useful Life of asset 2ND PRIORITY:
Requirements: LEASE TERM or USEFUL LIFE,
1. Purchase option whichever is SHORTER
2. Transfer of ownership

o Implicit rate vs. Incremental borrowing rate

- always use: Implicit rate
- last resort: Incremental borrowing rate

ROUA=LL
Rental payment (PV ord.) 1,000,000 x 5.65 = 5,650,000
Purchase Option (PV of 1) 500,000 x .32 = 160,000
Total 5,810,000

ROUA 5,810,000
Lease Liability 5,810,000

Intermediate Accounting 2 Page 2

Dep - ROUA Depreciation Expense - ROUA 434,167
5,810,000-600,000/12
Accumulated Depreciation 434,167

Date LP Interest (12%) Principal CA

Jan-1-2020 - - - 5,810,000
Dec-31-2020 1,000,000 697,200 302,800 5,507,200
Dec-31-2021 1,000,000 660,864 339,136 5,168,064
Dec-31-2022 1,000,000 620,168 379,832 4,788,232
Dec-31-2023 1,000,000 574,588 425,412 4,362,819
Dec-31-2024 1,000,000 523,538 476,462 3,886,358
Dec-31-2025 1,000,000 466,363 533,637 3,352,721
Dec-31-2026 1,000,000 402,326 597,674 2,755,047
Dec-31-2027 1,000,000 330,606 669,394 2,085,653
Dec-31-2028 1,000,000 250,278 749,722 1,335,931
Dec-31-2029 1,000,000 164,069 835,931 500,000

Year 1 Interest Expense 697,200

Lease Liability 302,800
Cash 1,000,000

Purchase Option entry Lease Liability 500,000

Cash 500,000

_____________________________________________________________________________________________

Illustration 3 - Residual value guarantee (p. 335)

On January 1, 2020, Lessee Company leased a machine with the following pertinent information:

Rental payment at the end of each year 1,000,000

Lease term 4 years
Useful life of machine 5 years
Implicit interest rate 10%
Residual value of machine - GUARANTEED 200,000

ROUA=LL
Rental payment (PV ord.) 1,000,000 x 3.170 = 3,170,000
Residual Value (PV of 1) 200,000 x .683 = 136,600
Total 3,306,600

ROUA 3,306,600
Lease Liability 3,306,600

Dep - ROUA Depreciation Expense - ROUA 776,650

3,306,600-200,000/4
Accumulated Depreciation 776,650

Intermediate Accounting 2 Page 3

 Date LP Interest (10% Principal CA
Jan-1-2020 - - - 3,306,600
Dec-31-2020 1,000,000 330,660 669,340 2,637,260
Dec-31-2021 1,000,000 263,726 736,274 1,900,986
Dec-31-2022 1,000,000 190,099 809,901 1,091,085
Dec-31-2023 1,000,000 108,915 891,085 200,000

Year 1 Interest Expense 330,660

Lease Liability 669,340
Cash 1,000,000

o As long as there is a residual value guarantee, there is no more purchase option because
the equipment shall revert to the lessor upon the expiration of the lease on December 31,
2023.

_____________________________________________________________________________________________

Illustration 4 - Initial Direct Cost (p. 338)

On January 1, 2020, Lessee Company leased a machine with the following pertinent information:

Rental payment at the beg. of each year 1,000,000

Lease term 5 years
Useful life 6 years
Implicit interest rate 8%
Residual value of machine - Guaranteed 300,000
IDC 250,000
Lease Incentive received 150,000
Lease Bonus 200,000

PV ord. computation of Rental 1.08 ÷ ÷ "Press = 4x" - 1 ÷ .08 = 3.3121

Payment (advance payment)
THEN;
3.3121 + 1 = 4.3121
PV of 1 computation of Residual 1.08 ÷ ÷ "Press = 5x" = .6806
Value (not advance payment)

ROUA =x LL
Rental payment (PV ord.) 1,000,000 x4.3121 = 4,312,100
Residual Value (PV of 1) 300,000 x .6806 = 204,180
Total LL 4,516,280
Add: IDC 250,000
Less: Lease Incentive (150,000)
received
Add: Lease Bonus 200,000
Total ROUA 4,816,280

ROUA 4,816,280
Lease Liability 4,516,280
Cash 300,000

Intermediate Accounting 2 Page 4

Dep - ROUA Depreciation Expense - ROUA 903,256
4,816,280-300,000/5
Accumulated Depreciation 903,256

Jan 1, 2020 Lease Liability 1,000,000

Cash 1,000,000

Date LP Interest Principal CA

Jan-1-2020 - - - 4,516,280
Jan-1-2020 1,000,000 0 1,000,000 3,516,280
Jan-1-2021 1,000,000 281,302 718,698 2,797,582
Jan-1-2022 1,000,000 223,807 776,193 2,021,389
Jan-1-2023 1,000,000 161,711 838,289 1,183,100
Jan-1-2024 1,000,000 94,648 905,352 277,748
Jan-1-2025 300,000 22,252 277,748 -

Dec 31, 2020 Interest Expense 281,302

Accrued Interest Payable 281,302

_____________________________________________________________________________________________

Illustration 5 - Unguaranteed Residual Value (p. 341)

On January 1, 2020, Lessee Company leased a machine with the following pertinent information:

Rental payment at the end. of each year 600,000

Lease term 6 years
Useful life 8 years
Implicit interest rate 10%
Residual value of machine - Unguaranteed 200,000
Discount rate 8%
Payment to lessor to obtain long-term lease - Lease bonus 224,000
Cost of restoring the asset 634,920
Executory cost - Expensed outright 50,000

The lease provides neither transfer of title nor purchase option

Note:
o Paid by the lessor - lease incentive
o Paid to the lessor - lease bonus

PV ord. computation of Rental Payment 1.10 ÷ ÷ "Press = 6x" - 1 ÷ .10 = 4.36

PV of 1 computation of Restoration Cost 1.08 ÷ ÷ "Press = 6x" = 0.63

ROUA =x LL
Rental payment (PV ord.) 600,000x4.36 = 2,616,000
Residual Value unguaranteed 0
Total LL 2,616,000

Intermediate Accounting 2 Page 5

 Total LL 2,616,000
Add: Lease Bonus 224,000
PV of 1 of Restoration 400,000
Cost
(634,920x0.63)
Total ROUA 3,240,000

2020 ROUA 3,240,000

Lease Liability 2,616,000
Estimated Liability - Restoration Cost 400,000
Cash 224,000

Dep - Depreciation Expense - ROUA 540,000

ROUA 3,240,000/6
Accumulated Depreciation 540,000

Executory Executory Cost 50,000

Cost
Cash 50,000

Rental Interest Expense (10%x2,616,000) 261,600

Payment
Lease Liability (600,000 - 261,600) 338,400
Cash 600,000

Restoration Interest Expense (8%x400,000) 32,600

Cost
Estimated Liability - Restoration Cost 32,000
2026
Return of Accumulated Depreciation (540,000x6) 3,240,000
equipment
to lessor
Equipment 3,240,000

Payment Estimated Liability - Restoration Cost 634,920

of liability
for
restoration
cost
Cash 634,920

Intermediate Accounting 2 Page 6