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Chapter 8
Leases Part 2

NAME: Date:
Professor: Section: Score:

QUIZ:
1. A lessor’s gross investment in a finance lease is computed as
a. lease payments plus unguaranteed residual value.
b. present value of (a).
c. difference between (a) and (b).
d. sum of (a) and (b).

2. Which of the following statements is false regarding the accounting for leases?
a. The lessor may not use the straight line basis for recognizing lease income
under an operating lease if another systematic basis is more representative of
the pattern in which benefit from the use of the underlying asset is
diminished.
b. The amount of lease income recognized each year under an operating lease is
typically constant even though the contractual payments increase every year
by a certain amount specified in the contract.
c. It is possible that the lessor does not depreciate the leased asset even if the
lease is classified as an operating lease.
d. Under an operating lease, the lessor capitalizes initial direct costs. These costs
will increase the lease income each year.

3. Security deposits that are refundable

a. are treated as unearned income by lessors under an operating lease.
b. are not discounted because they are normally of a short-term nature
c. are treated as receivable by lessees and as payable by lessors.
d. are discounted only by lessees but not by lessors

Use the following information for the next two questions:

On January 1, 20x1, VACILLATE Financing Co. leased equipment to HESITATE, Inc. Information on
the lease is shown below.
Cost of equipment ₱1,394,740
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the start of each year ₱400,000
Interest rate implicit in the lease 10%

4. How much is the total interest income (finance income) to be recognized by VACILLATE over
the lease term?
a. 400,000 c. 205,260
b. 605,260 d. 365,260

5. How much is the carrying amount of the net investment in the lease as of December 31, 20x1?
a. 694,215 c. 735,260
b. 1,094,215 d. 1,165,260
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6. On January 1, 20x1, OFFICIOUS Financing Co. leased equipment to MEDDLESOME, Inc. under
direct financing lease. Information on the lease is shown below:
Cost of equipment ₱1,200,000
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year ₱440,000
Non-lease component included in annual rent ₱36,196
Initial direct costs 80,000
Implicit rate of interest in the lease 10%

The non-lease component pertains to payment for supplies and other consumables relating to the
operation of the equipment. The stand-alone selling prices are: ₱36,196 for the supplies and ₱403,804
for the rent.

On January 1, 20x3, due to cash flow problems, OFFICIOUS agreed to sell the equipment to
MEDDLESOME, Inc. for ₱600,000. How much is the gain (loss) on the sale?
a. (100,816) c. 20,816
b. 100,816 d. 0

7. On January 1, 20x1, UPPITY Co. leased a piece of equipment to ARROGANT, Inc. Information
on the lease is shown below.
Cost of equipment ₱1,200,000
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year ?

UPPITY Co. incurred direct costs of ₱80,000 in negotiating the lease. If UPPITY Co. desires a fair rate
of return of 10%, what amount of annual rental should it charge ARROGANT, Inc.?
a. 440,000 c. 340,000
b. 403,803 d. 200,000

Use the following information for the next two questions:

On January 1, 20x1, POLTROON Co. leased a piece of equipment to COWARD, Inc. Information on
the lease is as follows:
Cost of equipment ₱1,200,000
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year ₱400,000
Interest rate implicit in the lease 10%
Residual value ₱80,000

The equipment will revert back to POLTROON at the end of the lease term. The lease is classified as
sales type lease.

8. How much is the gross investment in the lease on January 1, 20x1 assuming the residual value is
guaranteed?
a. 1,600,000 c. 1,520,000
b. 1,680,000 d. 1,267,948
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9. How much are the sales and cost of sales if the residual value is unguaranteed?
Sales Cost of sales Sales Cost of sales
a. 1,267,946 1,145,359 c. 1,322,587 1,200,000
b. 1,267,946 1,200,000 d. 1,322,587 1,145,359

10. On June 1, 20x0, Oren Co. entered into a five-year nonrenewable lease, commencing on that date,
for office space and made the following payments to Cant Properties:
Bonus to obtain lease 30,000
First month's rent 10,000
Last month's rent 10,000

In its income statement for the year ended June 30, 20x0, what amount should Cant report as rent
income?
a. 10,000 c. 40,000
b. 10,500 d. 0

"Come to me, all you who are weary and burdened, and I will give you rest." -
(Matthew 11:28-30)

- END -
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ANSWERS:
1. A
2. D
Choice (c) is a correct statement – for example, if the leased asset is land.

3. C

4. C
Gross investment before first collection (400K x 4) 1,600,000
Net investment before first collection (see below) (1,394,741)
Unearned interest income - 1/1/20x1 205,259

Annual rent 400,000

Multiply by: PV of annuity due of ₱1 @10%, n=4 3.486852
Net investment in the lease - 1/1/20x1 (before first collection) 1,394,741

5. B
Date Collections Interest Amortization Present value
1/1/x1 1,394,741
1/1/x1 400,000 0 400,000 994,741
1/1/x2 400,000 99,474 300,526 694,215
1/1/x3 400,000 69,422 330,578 363,637
1/1/x4 400,000 36,364 363,636 0

694,215 + 400,000 = 1,094,215

6. A
➢ Initial measurement:
Fixed lease payments (440,000 – 36,196) 403,804
Multiply by: PV of ordinary annuity of ₱1 @10%, n=4 3.169865
Net investment in the lease 1,280,004

➢ Subsequent measurement:
Date Collections Interest Amortization Present
income value
Jan. 1, 20x1 1,280,004
Dec. 31, 20x1 403,804 128,000 275,804 1,004,200
Dec. 31, 20x2 403,804 100,420 303,384 700,816

Jan. 1, Cash 600,000

20x3 Loss on sale (squeeze) 100,816
Finance lease receivable – net 700,816

7. B
Step 1: Place the given information in the equation.
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? + 0 = 1,200,000 (equal to cost) + 80,000

Step 2: Squeeze for ‘PV of lease payments.’

➢ ? = 1,200,000 + 80,000 – 0
➢ PV of lease payments = 1,280,000

Step 3: Squeeze for the lease payments

➢ PV of lease payments = Lease payments x PV factor
➢ 1,280,000 = Lease payments x PV of ordinary annuity @ 10%, n=4
➢ 1,280,000 = Lease payments x 3.169865
➢ Lease payments = (1,280,000 ÷ 3.169865) = 403,803

Use the following information for the next two questions:

On January 1, 20x1, POLTROON Co. leased a piece of equipment to COWARD, Inc. Information on
the lease is as follows:
Cost of equipment ₱1,200,000
Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year ₱400,000
Interest rate implicit in the lease 10%
Residual value ₱80,000

The equipment will revert back to POLTROON at the end of the lease term. The lease is classified as
sales type lease.

8. B (400,000 x 4 years) + 80,000 = 1,680,000

9. A
Guaranteed residual value Unguaranteed residual value
Sales (PV of annual rentals) 1,267,946 Sales (PV of annual rentals) 1,267,946
Add: PV of GRV 54,641 Cost of sales 1,200,000
Adjusted sales 1,322,587 Less: PV of URV ( 54,641)
Cost of sales (1,200,000) Adjusted cost of sales (1,145,359)
Gross profit 122,587 Gross profit 122,587

➢ PV of annual rentals: (400K x PV ordinary annuity @10%, n=4) = 1,267,946

➢ PV of residual value: (80,000 x PV of 1 @10%, n=4) = 54,641

10. B {10,000 + [(30,000 ÷ 5 years) x 1/12]} = 10,500