CHAPTER 12 Operating Lease – Lessor

Operating Lease
- It does not transfer substantially all the risks and rewards incidental to ownership of the
underlying assets. (meaning the owner of the property is still the lessor)

Finance Lease
- It transfers substantially all the risks and rewards incidental to ownership of the underlying
assets.

It is a Finance Lease if, any of the following criteria: (Lessors Point of View)
1. Transfer of ownership
2. Lessee has an option to purchase (Reasonably certain). Option price must be sufficiently lower than
fair value at the date the option becomes exercisable
3. Lease term is for the major part of the economic life of the underlying assets even if the title is not
transferred. (75% at least of the economic life of asset – under old standard)
4. Present Value of the lease payments amount to substantially all of the fair value of underlying
assets at the inception of the lease. (90% o Fair value of the lease asset)

Other Criteria
1. The underlying asset is of such specialized nature that only the lessee can use it without prior
modification
2. If the lessee can cancel the lease, the lessor losses associated with the cancelation are borne by the
lessee
3. Gains and losses from the fluctuation in the fair value of the residual accrue to the lessee
4. The lessee has the ability to continue the lease for secondary period at a rent that is substantially
lower than market rent.

LAND ND BUILDING
As a rule the lease payment shall be allocated to land and building in proportion to their respective
relative fair value at the inception of the lease.

- If the lease payment cannot be allocated to land and building reliably – The entire lease shall be
classified as finance lease. Unless it is clear that it is an operating lease.

Accounting: The amount received from the lessee shall be accounted by the lessor as RENTAL INCOME.

- The initial direct cost by the lessor – added to the value of the lease asset. It shall be recognized
as an expense (depreciation expense) over the lease term on the same basis as the lease
income.
- Security deposit refundable – it shall be accounted liability by the lessor.
- Lease bonus received from lessee – it shall be recognized as UNEARNED INCOME to be
amortized over the lease term.
Formula:
Unequal Lease payments
Year 1 Lease payments x
Year 2 Lease payments x
And Subsequent Years: Lease payments x
Less: Rent Free Granted to Lessee x
Total Payments x
Divide by: No. of Lease Term x
Average Annual Rental x

Average Rent Income X

Add: Amortization of Lease Bonus X
Total Rent Income X
Less: Expenses
Amortization of Initial Direct Cost) X
Depreciation X
Other Expenses X X
Net Income X

Problem 12-1
Equipment 3,000,000
Cash 3,000,000

Cash (40,000 x 9) 360,000

Rent Income 360,000

Cash 120,000
Unearned Rent Income 120,000
(lease bonus)

Repairs Expense 20,000

Cash 20,000

Unearned Rent Income 30,000

Rent Income (120K / 3 years x 9/12) 30,000

Depreciation expense 300,000

Accum. Dep (3M /10) 300,000

Rent Income (360K + 30K) 390,000

Less: Repair expense 20,000
Depreciation expense 30,000 50,000
Net Income 340,000

Problem 12-3
 Machinery 2,400,000
Cash 2,400,000

Cash (36,000 x 9) 324,000

Rent Income 324,000

Deferred Initial Direct Cost 120,000

Cash 120,000

Amortization of Initial Direct Cost 22,500

Deferred Initial Direct Cost 22,500
(120,000 /4 yrs x 9/12)

Depreciation expense 180,000

Accumulated Depreciation 180,000
(2,400,000/10 yrs x 9/12)

Machinery 2,400,000
Less: Accum. Depreciation 180,000
Book Value 2,220,000
Add: Deferred Initial Cost (120,000 - 22,500) 97,500
Adjusted Carrying Amount 2,317,500

Problem 12-7
2020
Rent Receivable 765,000
Rent Income (1,020,000 x 9/12) 765,000

Lease Payment (100,000 x 51 months) 5,100,000

Divide: No of Lease Term 5
Average Annual Rent 1,020,000

2021
Cash (100,000 x 12) 1,200,000
Rent Income 1,020,000
Rent Receivable 180,000

2025
Cash (100,000 x 3) 300,000
Rent Income (1,020,000 x 3/12) 255,000
Rent Receivable 45,000

12-10 C
 Year 1 Lease payments (1,200 x 1,000) 1,200,000
Year 2 Lease payments (3,000 x 1,000) 3,000,000
Year 3 Lease Payments (3,000 x 1,000) 3,000,000
Less: Rent Free Granted to Lessee -
Total Payments 7,200,000
Divide by: No. of Lease Term 3
Average Annual Rental 2,400,000
x No. of Months earned 9/12
Rental Income Jan. 1 – Sept 30 1,800,000

12-11 C
Year 1 Lease payments (800,000 x 6/12) 400,000
Year 2 Lease payments 1,250,000
Year 3 Lease Payments 1,250,000
Year 4 Lease Payments 1,250,000
Year 5 Lease Payments 1,250,000
Less: Rent Free Granted to Lessee -
Total Payments 5,400,000
Divide by: No. of Lease Term 5
Average Annual Rental 1,080,000

12-12 C
Year 1 Lease payments (100,000 x 12) 1,200,000
Year 2 Lease payments (150,000 x 12) 1,800,000
Year 3 Lease Payments (200,000 x 12) 2,400,000
Year 4 Lease Payments (250,000 x 12) 3,000,000
Total Payments 8,400,000
Divide by: No. of Lease Term 4
Average Annual Rental 2,100,000

Rent Income (2,100,000 x 2 years) 4,200,000

Less: Rent Collected year 2020-2021 (1.2M + 1.8M) 3,000,000
Rent Receivable 1,200,000

12-13 B
Year 1 Lease payments 1,000,000
 Year 2 Lease payments 1,000,000
Year 3 Lease Payments 1,400,000
Year 4 Lease Payments 1,700,000
Year 5 Lease Payments 1,900,000
Total Payments 7,000,000
Divide by: No. of Lease Term 5
Average Annual Rental 1,400,000

Rent Income (1,400,000 x 2 years) 2,800,000

Less: Rent Collected year 2020-2021 (1.2M + 1.8M) 2,000,000
Rent Receivable 800,000

12- 14 A
Rent Income 500,000
Less: Expenses
Amortization of Initial Direct Cost (150,000 / 10 yrs) 15,000
Depreciation 120,000
Insurance and Property Tax 90,000 225,000
Net Income 275,000

12-15 C
Average Annual Rental 900,000
Add: Amortization of Lease Bonus (500,000 / 5) 100,000
Total Rent Income 1,000,000

12-16 C
Average Rent Income 850,000
Add: Amortization of Lease Bonus (300,000 / 3) 100,000
Total Rent Income 950,000
Less: Expenses
Amortization of Initial Direct Cost) -
Depreciation 400,000
Insurance 80,000 480,000
Net Income 470,000

17 B
18 B
19 A
20 A
21 D/D/A/D/D
22 C/B/D/A/C
23 A/C/C/C/C/B