ILLUSTRATIVE EXAMPLES

Leases

Lessee
1. [Without transfer of title] On January 1, 2025, Company X entered into a lease for a new warehouse.
Lease payments are P800,000 a year for 5 years, payable in advance starting January 1, 2025. The
warehouse has an estimated life of 10 years. The entity paid initial direct cost of P100,000 on January 1,
2025. The realty taxes of P40,000 a year are to be paid by the entity.

The lease provides for neither transfer of title to the lessee upon expiration of the lease term nor a
purchase option. The underlying asset is reverted to the lessor at the expiration of the lease term. The
interest rate implicit in the lease is 10%. The relevant value factors are:

PV of an ordinary annuity of 1 at 10% for 5 periods 3.79

PV of an annuity of 1 in advance at 10% for 5 periods 4.17

Requirements:
1. Prepare journal entries on the books of Company X for 2025 and 2026.
2. Prepare journal entry upon expiration of the lease on January 1, 2030.

2. [With transfer of title] On January 1, 2025, Company X closed a lease contract for newly constructed
terminals and freight storage facilities. Although the terminals have a composite life of 10 years, the lease
runs for 5 years with a transfer of title to the lessee upon expiration of the lease.

The annual lease payment is P1,000,000 payable at the end of each year starting December 31, 2025. The
lessee must also make an annual payment of P75,000 for taxes and P125,000 for insurance. The lessee
incurred initial direct cost of P150,000. As an incentive to the lessee, the lessor agreed to reimburse the
lessee for the commission of P50,000.

The contract was negotiated to assure the lessor a 10% rate of return. The present value of an ordinary
annuity of 1 at 10% for five periods is 3.79. The present value of an annuity of 1 in advance at 10% for 5
periods is 4.17.

Requirement: Prepare journal entries on the books of Company X for 2025 and 2026 in connection with
the finance lease.
3. [With purchase option] On January 1, 2025, Company X leased a machine with the following provisions:

Annual lease payment in advance at the beginning of each year,

starting January 1, 2025 P1,000,000
Lease term 10 years
Useful life of machine 15 years
Implicit interest rate in the lease 12%
PV of an ordinary annuity of 1 at 12% for 10 periods 5.650
PV of an annuity of 1 in advance at 12% for 10 periods 6.328
PV of 1 at 12% for 10 periods 0.322

The entity has an option to purchase the machine on January 1, 2035 by paying P200,000. At the
commencement date, it is reasonably certain that the purchase option will be exercised.

Requirement: Prepare journal entries on the books of Company X for 2025 and 2026.

4. [With guaranteed residual value] On January 1, 2025, Company X leased a machine. Information on
the lease follows:

Annual rent payable at the start of each year P50,000

Lease term 4 years
Useful life of the machine 5 years
Implicit interest rate 12%
PV of annuity due of P1 at 12% 3.4018
PV of P1 at 12% 0.6355

Company X guarantees a residual value of P15,000 on lease expiration of which Company X expects
to pay on lease expiration when the leased asset is reverted back to the lessor.

Scenario 1: The fair value of the leased asset on January 1, 2029 is P15,000.

Scenario 2: The fair value of the leased asset on January 1, 2029 is P5,000.

Scenario 3: The fair value of the leased asset on January 1, 2029 is P20,000.

Requirement: Prepare the journal entries under the three scenarios above.
5. [With unguaranteed residual value] Company X has maintained a policy of acquiring equipment by
leasing. On January 1, 2025, Company X entered into a lease agreement for an equipment.

The lease stipulates an annual rental payment of P600,000 to be paid every December 31 starting
December 31, 2025. The lease contains neither a transfer of title to the lessee nor a purchase option.

The equipment has a residual value of P300,000 at the end of the 5-year lease period but is unguaranteed
by the lessee. The economic life of the equipment is 8 years.

The implicit interest rate is 12% after considering the unguaranteed residual value. The present value of
an ordinary annuity of 1 at 12% for 5 periods is 3.60.

Requirements:
1. Prepare journal entries on the books of Company X for 2025.
2. Prepare journal entry on December 31, 2029 to record the return of the equipment to the lessor
as required by the contract. The fair value of the equipment is P200,000.

6. [Operating lease - asset of low value] On January 1, 2025, Company X entered into a 3-year lease of a
group of office furniture with similar nature. Company X assessed that the lease is a lease of an underlying
asset of low value and elected to apply the recognition exemptions of IFRS 16.

The annual lease payments, payable at the end of each year, are as follows:

2025 P8,000
2026 12,000
2027 14,000

As an inducement to enter the lease, the lessor granted Company X the first six months of the lease as
rent-free.

Requirement: Prepare the journal entries from 2025 to 2027.

Lessor
7. [Direct Financing] Company X is in the business of leasing new sophisticated equipment. At the beginning
of current year, the equipment was delivered to a lessee under a direct financing lease with the following
provisions:

Cost of equipment P3,390,000

Annual rental payable at the end of year 600,000
Useful life and lease term 10 years
Implicit interest rate 11%
Present value of an ordinary annuity of 1 at 11% for 10 years 5.889

The entity incurred and paid initial direct costs of P143,400 in negotiating and arranging the lease. The
equipment will revert to Company X at the end of the lease.

Requirements:
1. Compute the total financial revenue to be recognized over the lease term.
2. Prepare journal entries on the books of Company X for the current year.

8. [Residual value: Guaranteed and Unguaranteed] On January 1, 2025, Company X leased equipment to
ABC Corporation. Information on the lease is shown below:

Cost of equipment P330,647

Useful life of equipment 5 years
Lease term 4 years
Annual rental payable at the end of each year 100,000
Interest rate implicit in the lease 10%
Residual value 20,000

The equipment will revert back to Company X at the end of the lease term. The lease is classified as direct
financing lease.

Requirements:
1. Compute for the following assuming the residual value is (1) guaranteed and (2) unguaranteed:
a. Gross investment in the lease on January 1, 2025.
b. Net investment in the lease on January 1, 2025.
c. Unearned interest income on January 1, 2025.

2. Prepare the journal entries under the following scenarios:

a. Scenario 1: The actual fair value (residual value) of the equipment on December 31, 2029 is
P20,000 (or more).
b. Scenario 2: The actual fair value (residual value) of the equipment on December 31, 2029 is
P5,000.
9. On January 1, 2025, Company X leased an equipment to another entity. The cost of the equipment to
Company X was P1,377,480 which approximates the fair value on the lease date. The expected economic
life of the equipment is also 4 years.

The lease payments stipulated in the lease are P440,000 per year in advance for a 4-year period of the
lease. The payments include P40,000 executory costs per year. The title to the equipment remains in the
hands of Company X at the end of the lease term, although only nominal residual value is expected at that
time.

The implicit interest rate in the lease is 11%. The fiscal year of Company X ends in December 31.

Requirements:
1. Compute the total financial revenue.
2. Prepare an amortization schedule for the lease receivable and interest income.
3. Prepare journal entries for 2025, 2026, 2027 and 2028.

10. [Sales type] On January 1, 2025, Company X leased equipment to Company Y for an eight-year period
expiring January 1, 2033. Equal payments under the lease are P600,000 and are due on January 1 of each
year. The first payment was made on January 1, 2025. The rate of interest contemplated is 10%.

The fair value of the equipment which is equal to the present value of lease payments is P3,520,000, and
the cost of the equipment is P2,800,000. Company X paid initial direct costs of P50,000 in negotiating and
arranging the lease.

The lease is appropriately recorded as a sales type lease.

Requirement: Prepare journal entries on the books of Company for 2025 and 2026.
11. On January 1, 2025, Company X, a dealer in equipment, leased equipment to Company Y. The lease is
appropriately accounted for as a sale by Company X and as a purchase by Company Y. The lease is for a
10-year period which approximates the useful life of the asset. The first of 10 equal annual payments of
P500,000 was made on January 1, 2025.

Company X purchased the equipment for P2,675,000 and established a list selling price (fair value) of
P3,375,000 on the equipment. Company X used the perpetual inventory system.

The present value on January 1, 2025 of the rent payments over the lease term discounted at 12% was
P3,165,000.

Requirement: Prepare journal entries for 2025 and 2026 on the books of Company X and Company Y.

12. [With residual value] On January 1, 2025, Company X leased equipment with ABC Corporation.
Information on the lease is shown below:

Cost of equipment P300,000

Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of each year 100,000
Market rate of interest 10%
Residual value 20,000
Present value of an ordinary annuity at 10% for 4 years 3.16987
Present value of 1 at 10% for 4 years 0.683

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

Requirements: Compute for the following assuming the residual value is (1) guaranteed and (2)
unguaranteed:
a. Gross investment in the lease on January 1, 2025.
b. Net investment in the lease on January 1, 2025.
c. Total interest income (finance income) to be recognized by Company X over the lease term.
d. Sales, Cost of sales, and Gross profit recognized on the lease.
e. Provide the journal entries.
13. [With transfer of ownership] Company X used leases as a method of selling products and followed the
perpetual inventory system. On January 1, 2025, a machinery was leased to another entity on a contract
specifying that ownership of the machinery will transfer to the lessee at the end of the lease term.

Cost of machinery to Company X P6,000,000

Annual rental payable in advance 900,000
Estimated residual value 300,000
Implicit interest rate 10%
Lease period 20 years
Date of first rental payment January 1, 2025
PV of an annuity of 1 in advance at 10% for 20 periods 9.36
PV of 1 at 10% for 20 periods 0.15

Requirements:
1. Determine the total financial revenue.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2025 and 2026.

14. [With purchase option] Company X is a dealer in equipment. On January 1, 2025, the entity leased an
equipment to another entity. The lease is appropriately recorded as a sales type lease.

Annual rental payable at the beginning of each year P875,000

Lease term 8 years
Useful life of equipment 10 years
Cost of equipment 3,100,000
Purchase option 300,000
Implicit interest rate 10%
PV of an annuity of 1 in advance at 10% for 8 periods 5.8684
PV of 1 at 10% for 8 periods 0.4665

It is reasonably certain that the lessee will exercise the purchase option on the expiration of lease on
December 31, 2032 The perpetual inventory system is used by Company X.

Requirements:
1. Determine the unearned interest income on January 1, 2025.
2. Determine the gross profit on sale.
3. Prepare journal entries for 2025 and 2026.
4. Prepare journal entry on December 31, 2032 to record the exercise of the bargain purchase option
by the lessee.
5. Prepare journal entry on December 31, 2032 if the bargain purchase option is not exercised by the
lessee and the fair value of the leased asset is P200,000.
15. [Operating lease] On January 1, 2025, Company X purchased an equipment for P3,000,000 cash for the
purpose of leasing it. The machine is expected to have a 10-year life from the date of purchase.

On April 1, 2025, the equipment was leased to Company Y for a three-year period, at a monthly rental of
P40,000 payable at the end of every month. Additionally, Company Y paid P120,000 to Company X on
April 1, 2025 as a lease bonus. Company X paid repairs of P20,000 relating to 2025.

Requirements:
1. Prepare journal entries on the books of the lessor following the operating lease model.
2. Compute the net rent income of the lessor for 2025.

16. [With initial direct cost] On April 1, 2025, Company X purchased a machine for P2,400,000 for the purpose
of leasing it to others. The machine is expected to have a 10-year life and no residual value. It will be
depreciated on the straight line basis computed to the nearest month.

The machine was leased to Company Y on April 1, 2025 for four years, at a monthly rental of P36,000.
There is no provision for renewal of the lease or purchase of the machine by the lessee upon expiration
of the lease. Company X paid P120,000 initial direct costs associated with negotiating the lease in March
2025.

Requirements:
1. Prepare journal entries on the books of the lessor for 2025.
2. Present the machinery in the statement of financial position of Company X on December 31, 2025

17. [With grace period] As an inducement to enter a lease, Company X a lessor grants Company Y, a lessee,
nine months of free rent under a five year operating lease. The lease is effective on April 1, 2025 and
provides for monthly rental of P100,000 to begin January 1, 2026.

Requirement: Prepare journal entries on the books of the lessor over the 5-year lease term.
Sale and leaseback
18. [Operating lease] At the beginning of current year, Company X sold an equipment to Company Y for
P1,200,000 which is the fair value of the equipment. The equipment had a cost of P2,500,000, carrying
amount of P1,000,000 and remaining useful life of 5 years.

On the same day, Company X leased back the equipment for one year for an annual rental of P300,000
payable at the beginning of the year. Company X has no option to renew or repurchase the equipment.

Requirement: Prepare journal entries for the current year to record the sale and leaseback transaction on
the books of Company X and Company Y.

19. [Finance lease] On January 1, 2025, Company X sells a building to Company Y and simultaneously leases
it back. Additional information are as follows:

Fair value of building P1,000,000

Carrying amount 800,000
Remaining useful life of building 10 years
Lease term 5 years
Annual rent payable at the end of each year 100,000
Implicit interest rate 12%
PV of an ordinary annuity at 12% for 5 periods 3.60478

Requirement: Prepare the journal entries from the point of view of Company X and Company Y:

Scenario 1: The sale price is P1,000,000 (equal to fair value).

Scenario 2: The sale price is P1,100,000 (above fair value).
Scenario 3: The sale price is P900,000 (below fair value).