Finance Lease: Demo Teaching Presentation

FINANCE
LEASE
DEMO TEACHING PRESENTATION
July 11, 2016
Hannah Faye Krystle Reyes, CPA
Finance Lease
DEFINITION
It is a lease that transfers substantially
all the risk and rewards incident to
ownership of an asset.
STANDARD
PAS 17
PRINCIPLE
Substance over form
Criteria
YES
NO
Is the lease non-cancelable?

Ownership transferred by the end of lease term?
Contain a bargain purchase option?
Lease term major part of assets useful life?
Present value of Minimum Lease Payment greater than or substantially
equal to assets fair value?
Special in nature that only the lessee can use it without modification?
OPERATING
LEASE
FINANCE
LEASE
Criteria
Substance over Form
Transfer of Risk and Rewards
Criteria
Bargain Purchase Option lessee the option to purchase the asset in a sufficiently
lower than fair value of the asset at end of lease term ;
At the inception of the lease the BPO shall be reasonable certain that the option
shall be exercised
Criteria
Major Part 75% (US GAAP)
Criteria
Minimum Lease Payment - payment required from the lessee and includes the
following: Ownership transferred by the end of lease term?
(a) Annual Rental
(b) Bargain Purchase Option
Contain
(c) Guaranteed residual
valuea bargain purchase option?

Substantially (US GAAP) Quantitative threshold 90%
Criteria
Special in nature that only the lessee can use it without modification?
Important Dates
Inception of the Lease earlier of the date of agreement or date of commitment to

principal provisions
Commencement of the lease when the lessee is entitled to exercise to use the
leased asset. It is when the related asset, liabilities, income and expense are initially
recognized.
Land & Building

Land operating lease unless title will pass at the end of lease term
Amended: Can be classified as Finance Lease if the lease term is for several decades
or longer.
Building to apply Finance Lease Criteria
Minimum Lease Payments are allocated based on relative fair value of the land and
building.
Accounting for Finance Lease LESSEE

On January 1, 2015, Hazel Company leased an equipment from Jo Company with the
following pertinent information:
Annual Rental
500,000
Lease Term
8 years
Useful Life of equipment
10 years
Implicit interest rate
10%
PV of an ordinary annuity of 1 for 8 period at 10%
PV of 1 for 8 periods at 10%
0.47
5.33
The entity has the option to purchase the equipment on January 1, 2023 by paying
P500,000 which is sufficiently lower than the expected fair value of the equipment.
There is reasonable certainty that the option will be exercised. On January 1, 2015, the
entity also incurred initial direct cost of P200,000.
Hazel Company Lessee
Jo Company - Lessor

On January 1, 2015, Hazel Company leased an equipment from Jo Company with the following pertinent
information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33
The entity has the option to purchase the equipment on January 1, 2023 by paying P500,000 which is sufficiently
lower than the expected fair value of the equipment. There is reasonable certainty that the option will be
exercised. On January 1, 2015, the entity also incurred initial direct cost of P200,000.
What is the initial cost of the equipment?

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
Does the transaction meet any one of the criteria for it to be

Finance Lease?
Yes:
(a) Bargain Purchase Option
(b) Lease is a major part of asset life (80%)
(c) MLP is substantially all of the assets fair value

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
Shall the lessee recognize the asset in its books?

Yes:
Finance Lease is an installment purchase of asset in
substance. Thus, the lessee shall recognize the asset in its
books and its related liabilities.

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000

Yes:

information:
At how much shall the lessee recognize the asset?

Annual Rental
500,000
Lease Term
8 years
10 years
10%
ASSET = Lower
of ;
0.47
5.33
The entity has the option to (a)

purchase
the equipment
January 1, 2023 by paying P500,000 which is sufficiently
Fair Value
of theon
asset
lower than the expected fair
of theValue
equipment.
There is reasonable
certainty that the option will be
(b)value
Present
of Minimum
Lease Payments

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000

Yes:

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
Shall we include the PV of BPO?

Rental Payment= 500,000 * 5.33
=
PV of BPO = 500,000 * 0.47
=
Total
=
2,900,000
2,665,000
235,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
OR
Shall we include the PV of BPO?

=
PV of BPO = 500,000 * 0.47
=
Total
=
2,900,000
Shall we include the PV of Initial Direct Cost?

=
2,665,000
Initial Direct Cost
=
200,000
Total
=
2,865,000
2,665,000
235,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
OR
Shall we include both of them?

PV of Rental Payment= 500,000 * 5.33
=
PV of BPO = 500,000*0.47
=
235,000
Initial Direct Cost
=
200,000
Total
=
3,100,000
2,665,000

ANSWER:
information:
Annual Rental
500,000
Lease Term
8 years
ASSET
=
Lower
of
;
10 years
10%
PV of an ordinary
of 1 for
period
at 10%
5.33
(a)annuity
Fair Value
of8the
asset
PV of 1 for 8 periods
at 10% Value of Minimum
0.47 Lease Payments (Annual Rental and BPO)
(b) Present
Initial
direct 1,
cost
incurred
byalso
theincurred
lessee is
capitalized
asofcost
of the asset as it is directly
exercised.
On January
2015,
the entity
initial
direct cost
P200,000.
attributable to the leasing activity.

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
OR
Shall we include both of them?

PV of Rental Payment= 500,000 * 5.33
=
PV of BPO = 500,000*0.47
=
235,000
Initial Direct Cost
=
200,000
Total
=
3,100,000
2,665,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
0
2,900,000
2,865,000
3,100,000
Equipment
3,100,000
Lease Liability
2,900,000
Cash
200,000
To record cost of asset in Hazels books
The only amount that will make the leased asset and lease liability differ is the
Initial Direct Cost.

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
ANSWER:
5.33
What is the interest expense for the year?

a.
b.
c.
d.
290,000
310,000
266,500
316,500
Interest expense is based on the Lease Liability.

2,900,000 * 10% = 290,000
Note: Interest expense is not the same every year since it will be based on the
amortization schedule.

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33
What is the interest expense for the year?

a.
b.
c.
d.
290,000
310,000
266,500
316,500
December 31, 2015 Interest Expense

Lease Liability
210,000
Cash
500,000
290,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33
Answer:
A
What is the lease liability on December 31, 2015?

a.
b.
c.
d.
2,690,000
2,790,000
2,398,500
2,848,500
Initial Lease Liability

2,900,000
Principal Prepayment
(210,000)
Lease Liability, December 31, 2015
2,690,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33
What is the depreciation for year 2015?

a.
b.
c.
d.
310,000
387,500
290,000
362,500
Where will Hazels company base the depreciation?

ASSET.

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
310,000
387,500
290,000
362,500
What shall be used? Lease term or asset useful life?
USEFUL LIFE
(a) Transfer of Ownership
LEASE TERM or USEFUL LIFE,

whichever is SHORTER
Other than (a) and (b)

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
310,000
387,500
290,000
362,500
What shall be used? Lease term or asset useful life?
USEFUL LIFE

Depreciation = Leased Equipment Residual Value
Useful Life

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
310,000
387,500
290,000
362,500
Answer:
Depreciation = Leased Equipment Residual Value

Useful Life
A
Asset
3,100,000
Useful Life
10
Depreciation Expense 310,000

information:
Annual Rental
500,000
Lease Term
8 years
10 years
10%
0.47
5.33

a.
b.
c.
d.
310,000
387,500
290,000
362,500
Dec 31, 2015
Depreciation Expense
310,000
Accumulated Depreciation Leased Asset
310,000

At the beginning of current year, Janette Company entered into an 8-year lease for an equipment. The entity
accounted for the acquisition as a finance lease for 6,000,000 which included a 600,000 guaranteed residual value. At
the end of the lease, the asset will revert back to the lessor. It is estimated that the fair value of the asset at the end
of 10 year useful life would be 400,000. The entity used the straight line depreciation.

a.
b.
c.
d.
675,000
700,000
540,000
560,000
USEFUL LIFE
Depreciation = Leased Equipment Guaranteed Residual Value

Useful Life or Lease term, w/c ever is lower


At the beginning of current year, Janette Company entered into an 8-year lease for an equipment. The entity
accounted for the acquisition as a finance lease for 6,000,000 which included a 600,000 guaranteed residual value. At
the end of the lease, the asset will revert back to the lessor. It is estimated that the fair value of the asset at the end
of 10 year useful life would be 400,000. The entity used the straight line depreciation.

a.
b.
c.
d.
675,000
700,000
540,000
560,000
Answer:
A
Depreciation = Leased Equipment Guaranteed Residual Value

Useful Life or Lease term, w/c ever is lower
Depreciation = 6,000,000 600,000

8
675,000
Accounting for Finance Lease LESSOR
Direct Financing Lease
Sales Type Lease

Arrangement between the financing entity and lessee.
Income of the lessor is in form of interest income only

No dealer profit is recognized because the fair value of
asset and the cost of asset is equal.
Sales Type Lease
Sales Type Lease

Actually a manufacturing or dealer that uses the lease as a
means of facilitating the sale of its product.
Involves recognition of profit since the fair value is greater
than cost of asset.

BPO
No transfer of title/
Revert
Not Revert
Gross Investment
Gross Rental +
BPO
Gross Rental+
Residual Value,
whether guaranteed
or not
Gross Rental
Net Investment
Present Value of
Gross Receivable
Present Value of
Gross Receivable
Present Value of
Gross Receivable
Or
Or
Or
Cost of Asset +
Initial Direct Cost,
lessor
Cost of Asset +
lessor
Cost of Asset +
lessor
GI - NI
GI - NI
GI - NI
Unearned Income

Toots Company is in the business of leasing new equipment. The lessor expects a 12% return on its net
investment. All leases are classified as direct finance lease. At the end of the lease term, the equipment revert
back to lessor. On January 1, 2015, an equipment is leased with the ff. information:
Answer
Cost of equipment
Residual Value unguaranteed
Annual rental payable in advance
Useful life and lease term
5,000,000
600,000
900,000
8 years
12%
Gross Investment
What is the gross investment in lease?

a.
b.
c.
d.
7,2000,000
7,800,000
5,000,000
5,250,000
Net Investment
Gross Rental = (900,000*8 )
Unguaranteed Residual Value
Gross Investment
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
Gross Receivable
= 7,200,000
= 600,000 Or
7,800,000
Cost of Asset +

Answer
Cost of equipment
Initial direct costs
5,000,000
600,000
900,000
8 years
12%
250,000
What is the net investment in lease?

a.
b.
c.
d.
5,000,000
5,250,000
4,400,000
4,650,000
Gross Investment
PV of Gross Investment
Net Investment
900,000 *5.5638=
5,007,420
600,000 * 0.404=
242,580
5,250,000
OR
Cost of Asset 5,000,000
Initial Direct Cost 250,000
5,250,000
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
Gross Receivable
Or
Cost of Asset +

Answer
Cost of equipment
5,000,000
600,000
900,000
8 years
12%
250,000
Gross Investment
What is the unearned interest income?

a.
b.
c.
d.
Net Investment
2,550,000
1,950,000
3,150,000
1,500,000
Gross Investment
Net Investment
Unearned Income
7,800,000
5,250,000
2,550,000
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
Gross Receivable
Or
Cost of Asset +

Answer
Cost of equipment
5,000,000
600,000
900,000
8 years
12%
250,000
What is the interest income for 2015?

a.
b.
c.
d.
594,000
522,000
630,000
450,000
Net Investment
5,250,000
Principal Repayment , January 1 (900,000)
4,350,000
IR
12%
Interest income
522,000

Cost of equipment
5,000,000
600,000
900,000
8 years
12%
250,000
January 1, 2015
Lease Receivable
7,800,000
Equipment
5,000,000
Cash
250,000
Unearned Interest Income
2,550,000
January 1, 2015
Cash
Lease Receivable
900,000
900,000

Cost of equipment
5,000,000
600,000
900,000
8 years
12%
250,000
December 31, 2015

Unearned Interest Income
Lease Receivable
522,000
522,000

Sales Type Lease
BPO
Revert
Not Revert
Gross Investment
Gross Rental +
BPO
Gross Rental+
Residual Value,
whether guaranteed
or not
Gross Rental
Net Investment
Present Value of
Gross Receivable
Present Value of
Gross Receivable
Present Value of
Gross Receivable
Unearned Income
GI - NI
GI - NI
GI - NI
Cost of asset is NOT EQUAL to Fair Value of asset.

Net Investment Cost of Asset = Gross Profit (recognized immediately)
Initial Direct Cost, lessor = expensed outright

Luis Company is a dealer in equipment. On January 1, 2015, an equipment was leased to another entity with the
following provisions:
Annual rental at the end of the year
1,500,000
Lease term and useful life of the machinery
5 years
Cost of equipment
4,000,000
Guaranteed residual value
500,000
12%
PV of an ordinary annuity of 1 for 5 periods at 12%
3.60
.57
Answer
B
At the end of lease term, the equipment will revert back to the lessor. The perpetual inventory system is used. The
lessor incurred initial direct cost of 200,000.
What is the gross investment in lease?

a.
b.
c.
d.
7,500,000
8,000,000
4,000,000
4,500,000
Gross Investment
Net Investment
Gross Investment
Gross Rental (1,500,000* 5)
GRV
500,000
Unearned
Income
8,000,000
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
Gross Receivable
7,500,000
GI - NI

1,500,000
5 years
Cost of equipment
4,000,000
500,000
12%
3.60
.57
Answer
B
What is the net investment in lease?

a. 5,400,000
b. 5,685,000
c. 4,000,000
d. 3,500,000
Gross Investment
Net Investment
Gross Investment
PV of Gross Rental (1,500,000* 3.60)
PV of GRV
285,000
Unearned
Income
5,685,000
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
Gross Receivable
5,400,000
GI - NI

1,500,000
5 years
Cost of equipment
4,000,000
500,000
12%
3.60
.57
Answer
A
What is the total financial revenue?

a. 2,315,000
b. 1,815,000
c. 2,100,000
d. 2,600,00
Gross Investment
Gross Investment
Net Investment
Gross Investment
Net Investment
Unearned Income
Unearned Income
Revert
Gross Rental+
Residual Value,
whether guaranteed
or not
Present Value of
8,000,000
Gross Receivable
5,685,000
2,315,000
GI - NI

1,500,000
5 years
Cost of equipment
4,000,000
500,000
12%
3.60
.57
Answer
A
What amount shall be reported as profit on sale?

a.
b.
c.
d.
1,485,000
1,685,000
3,500,000
4,000,000
Net Investment (Sales)

Cost of Asset
Gross Profit
5,685,000
4,000,000
1,685,000
Gross Profit
Initial Direct Cost
Profit on Sale
1,685,000
(200,000)
1,485,000

Gross Investment
Gross Investment
Net Investment
Unearned Income
January 1, 2015
Lease Receivable
Sales
Unearned Income
Cost of Sales
Inventory
Cash
8,000,000
5,685,000
2,315,000
4,200,000
4,000,000
200,000
Initial direct cost is capitalized as cost of
sale.
8,000,000
5,685,000
2,315,000
Net Investment (Sales) 5,685,000

Cost of Asset
4,000,000
Gross Profit
1,685,000
Gross Profit
1,685,000
Initial Direct Cost
(200,000)
Profit on Sale
1,485,000

1,500,000
5 years
Cost of equipment
4,000,000
500,000
12%
3.60
.57
Answer
A
What amount shall be reported as interest income?

a.
b.
c.
d.
682,200
648,000
900,000
960,000
Net Investment (Sales)

IR
12%
Interest income
5,685,000
682,200
Questions?
-ENDThank you and God

Bless!

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FINANCE

Hannah Faye Krystle Reyes, CPA

Is the lease non-cancelable?

Transfer of Risk and Rewards

Major Part 75% (US GAAP)

Lease term major part of assets useful life?

Substantially (US GAAP) Quantitative threshold 90%

Inception of the Lease earlier of the date of agreement or date of commitment to

Land & Building

Accounting for Finance Lease LESSEE

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Does the transaction meet any one of the criteria for it to be

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Shall the lessee recognize the asset in its books?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Shall the lessee recognize the asset in its books?

Accounting for Finance Lease LESSEE

At how much shall the lessee recognize the asset?

The entity has the option to (a)

What is the initial cost of the equipment?

Shall the lessee recognize the asset in its books?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Shall we include the PV of BPO?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Shall we include the PV of BPO?

Shall we include the PV of Initial Direct Cost?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Shall we include both of them?

Accounting for Finance Lease LESSEE

attributable to the leasing activity.

Shall we include both of them?

Accounting for Finance Lease LESSEE

What is the initial cost of the equipment?

Accounting for Finance Lease LESSEE

What is the interest expense for the year?

Interest expense is based on the Lease Liability.

Accounting for Finance Lease LESSEE

What is the interest expense for the year?

December 31, 2015 Interest Expense

Accounting for Finance Lease LESSEE

What is the lease liability on December 31, 2015?

Initial Lease Liability

Accounting for Finance Lease LESSEE

What is the depreciation for year 2015?

Where will Hazels company base the depreciation?

Accounting for Finance Lease LESSEE

What is the depreciation for year 2015?

What shall be used? Lease term or asset useful life?

LEASE TERM or USEFUL LIFE,

Accounting for Finance Lease LESSEE

What is the depreciation for year 2015?

What shall be used? Lease term or asset useful life?

LEASE TERM or USEFUL LIFE,

Accounting for Finance Lease LESSEE

What is the depreciation for year 2015?