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Financial Accounting Lease Exercises

The document contains exercises on financial accounting and reporting related to leases, including finance and operating leases for both lessees and lessors. It presents various scenarios involving lease payments, depreciation, interest income, and capitalized amounts, along with multiple-choice questions for calculations. The exercises are designed for students at St. Thomas More College to apply their knowledge of lease accounting principles.

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Crisel Silva
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38 views3 pages

Financial Accounting Lease Exercises

The document contains exercises on financial accounting and reporting related to leases, including finance and operating leases for both lessees and lessors. It presents various scenarios involving lease payments, depreciation, interest income, and capitalized amounts, along with multiple-choice questions for calculations. The exercises are designed for students at St. Thomas More College to apply their knowledge of lease accounting principles.

Uploaded by

Crisel Silva
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

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%

Page 1 of 3
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

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

4. What is the interest income for 2013?


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

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

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

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

8. What is the interest income for 2013?


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

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?

Page 2 of 3
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

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

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

Page 3 of 3

Common questions

Powered by AI

A lessor should consider whether the lease transfers substantially all economic benefits and risks to the lessee, the lease's payment structure, the duration relative to the asset's useful life, and whether it includes a bargain purchase option. If the lease transfers sufficient risks and benefits and the present value of lease payments plus any residual value equals or exceeds substantially all of the asset’s fair value, it is classified as a direct financing lease .

Changes in the estimated residual value affect the lease receivable by altering the amount of unearned income and potentially the lease's implicit interest rate. An increase in residual value decreases the present value needed to be recovered through lease payments, potentially increasing uncertainty and interest income variation if unguaranteed. This change requires adjusting future accounting treatments for income recognition .

At the commencement, the lessee records an asset and a corresponding liability at the present value of the lease payments. The journal entry includes debiting a 'Right-of-use Asset' account and crediting a 'Lease Liability' account. The asset is subsequently depreciated over its useful life, while the liability is amortized through payments splitting between principal and interest .

The presence of a guaranteed residual value reduces the amount of unearned interest income to be recognized, as it increases the certainty of recovering more of the lease investment. If the residual value is unguaranteed, it increases the uncertainty and thus the amount of unearned interest income, as the lessor cannot be assured of receiving this amount without risk .

Initial direct costs incurred by the lessor are included in the net investment of the lease and affect its effective interest rate, impacting the calculation of unearned interest income. These costs typically reduce the lessor's recognized profit in the period they are expensed, despite being capitalized as part of the lease receivable .

Jonli Enterprises needs to consider the present value of the purchase option price in comparison to the estimated fair market value of the machine after the lease period, as well as their anticipated continued utility of the asset. If the present value of the purchase option is significantly lower than the fair market value, and the asset is still expected to be productive for the company, purchasing the asset would be financially advantageous .

The lessor calculates gross profit by subtracting the carrying amount of the asset from the fair value of the leased asset (or the present value of the minimum lease payments when applicable). This difference reflects the profit component inherent in the lease agreement .

The implicit interest rate is used to discount the lease payments and the purchase option (if any) to present value, which determines the capitalized amount on the balance sheet and affects the periodic interest and depreciation expenses. It ensures that the lease payments are split between reducing the lease liability and recognizing interest expense over the lease term .

Interest income recognition affects both the income statement and the balance sheet. It increases the lessor's revenue, providing periodic income through the lease term. This recognition also decreases the lease receivable on the balance sheet as the periodic payments are used to amortize the lease, moving portions from unearned to earned revenue .

Wall Company should spread the total rental payments over the five-year lease term, accounting for the rent-free period. Thus, they would likely recognize rental income on a straight-line basis over the entire term, despite the rent-free period at the beginning. This results in rental income of P1,080,000 for 2013, considering the average annual rental .

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