CHAPTER 7

LEASES (Part 1)
Reporters: Gador, Diannah Jayne M. & Gaitera, Fel An
References:
• Intermediate Accounting 2
(Zeus Vernon B. Millan) 2023 edition
• Sir Win - Accounting Lectures
(Youtube Channel)
• 2 Minutes Business Videos
(Youtube Channel)
• Intermediate Accounting 2
(Conrado T. Valix, Jose F. Perralta,
Christian Aris M. Valix) 2021 Edition
• Accounting Lecture Series (Youtube Channel)
 Learning

OBJECTIVES
01 02
Identify a lease Account for leases by a lessee
using (a) the general
recognition and (b) the
recognition exemption
LEASE
is defined as a contract or
part of a contract that
conveys the right to control
the use of an underlying
assets for a period of time in
exchange of consideration. A
contract must convey the
right to control the use of an
LEASE
identified = RENT
asset.

Sir Win- Accounting Lectures

LESSOR (underlying asset) LESSEE
(provides) (obtains)
 An entity has the right to control the use of
an identified asset if it has both of the
Identifying a
following throughout the period of use.
LEASE
a. the right to obtain substantially all of the
economic benefits from the use of the
identified asset; and
b. the right to direct the use of the
identified asset
 Identified
ASSET Illustration:
Customer X enters into a five-year contract with
An identified asset is essential in the Supplier Y for the use of towing truck The
definition of a lease. An asset can be specification of the truck (i.e., brand brand,
identfieid by being explicitly stated in engine, capacity, dimension, etc.) is stated in
the contract or by being implicitly the contract (page 287)
specified at the time the asset is made
available for use by the customer.
 Portions of
ASSETS Illustration:
Customer X enters into a 10-year contract with
An identified asset is essential in the Supplier Y for the right to use three fibres within
definition of a lease. An asset can be a larger cable (consisting fibres) connecting
identfieid by being explicitly stated in Country A and B. (page 288)
the contract or by being implicitly
specified at the time the asset is made
available for use by the customer.
Substantive substitution An asset is not an identified asset
if the supplier has the substantive
rights
right to substitute it throughout
the period.
 SUBSTANTIVE NOT SUBSTANTIVE
if it cannot be exercised
throughout the period of use, such
a. the supplier has the practical ability
as when substitution is made:
to substitute alternative assets
throughout the period use. a. only on a particular date or upon the
occurence of a specified event; or

b. the supplier would benefit b. only during repairs, maintenance or

economically from the exercise of its upgrading.
right to substitute the asset.
 Right to obtain A customer controls the use of an
identified asset if the right to
economic benefits from
obtain substantially all of the
use
economic benefits from the asset
throughout the period of use.
 a. the customer has the right to
direct how and for what purpose
Right to
the asset is used throughout the
direct the use period of use; or

b. the asset’s use is

predetermined and the supplier is
precluded from changing that
predetermined use.
 Protective rights include contractual
restrictions designed to protect the
supplier’s interest in the asset or its
Protective
personnel, or to ensure compliance with
rights laws or regulations

It typically define the scope of the

customer’s right of use but do not, in
isolation, prevent the customer from having
the right to direct the use of asset.
Identifying a Lease:
A contract between a customer and a supplier who owns a huge shopping mall, where the
supplier grants the customer the right to use a specified space at the entrance of the mall, to
put a stand for selling its goods. The customer has an exclusive use of that space. Also, the
customer can decide what goods to be sold, when to sell them, and the quantity of goods to
be held on the stand. The supplier only provides security and maintenance related to the
space used by the customer. According to the terms of the contract, the supplier has the right
to require the customer to relocate to another space in the mall without the customer's
consent. The shopping mall has got many alternative spaces that can be used as substitute
for the current space used by the customer. The customer's stand can be moved easily to
any other space. There are ongoing renovations in the mall that will change the interior
design of the mall, and will create some amusement park areas, that are expected to
increase the number of visitors to the mall. Assess whether that contract includes a lease.
Identifying a Lease:
A contract between a customer and a supplier who owns a huge shopping mall, where the
supplier grants the customer the right to use a specified space at the entrance of the mall, to
put a stand for selling its goods. The customer has an exclusive use of that space. Also, the
customer can decide what goods to be sold, when to sell them, and the quantity of goods to
be held on the stand. The supplier only provides security and maintenance related to the
space used by the customer. According to the terms of the contract, the supplier has the right
to require the customer to relocate to another space in the mall without the customer's
consent. The shopping mall has got many alternative spaces that can be used as substitute
for the current space used by the customer. The customer's stand can be moved easily to
any other space. There are ongoing renovations in the mall that will change the interior
design of the mall, and will create some amusement park areas, that are expected to
increase the number of visitors to the mall. Assess whether that contract includes a lease.
 PROBLEM 6: CLASSROOM
DISCUSSION
• Customer X enters into a contract with Supplier Y
for the use of a specific car for one year. The car
shall be modified according to the specifications of
Customer X. Customer X shall have exclusive use
of the car during the duration of the contract. If at
any time the car is not working properly, Supplier Y
shall provide a replacement car of the same type.
Supplier Y cannot retrieve the car during the
duration of the contract for reasons other than the
default of Customer X. At the time of signing of
contract, Supplier Y does not yet have the car
 Essential Elements Guidance

• The car is implicitly specified at the time

that the asset is made available for use
by the customer.
• Substitution right - Supplier Y’s
• Identified asset substitution rights is not substantive
because it is not available to Supplier Y
throughout the period of use.
• Based on the foregoing, the car is an
identified asset.
 Essential Elements Guidance

• Customer X has the exclusive use of the

2. Right to obtain car throughout the duration of the contract
substantially all of the Therefore, Customer X has the right to
economic benefits obtain substantially all of the economic
benefits of the car.

• Customer X has the right to direct how and

3. Right to direct the use for what purpose the asset is used
throughout the period of use

CONCLUSIONS: THE CONTRACT IS A LEASE

 2. Customer X enters into a three-year contract with
PROBLEM 6:
Supplier Y for the use of a bus. The bus shall be used as
CLASSROOM DISCUSSION a shuttle service for Customer X's guests. Supplier Y
owns a fleet of buses and each bus meets the
specifications of Customer X. The contract requires
Supplier Y to make available for Customer X the use of a
bus throughout the duration of the contract. Supplier Y
provides a driver for the bus and decides which one of its
many buses will be used by Customer X. The decision
would depend, for example, on the number of guests that
will be using the bus and the destination - whether long
trip or short trip. Customer X decides the time of use and
the destination Only the guests of Customer X shall be
the passengers when the bus is used. After Customer X's
use, the bus is kept in Supplier Y's premises.
 Essential Elements Guidance

• There is no identified asset because

1 . Identified asset Supplier Y’s substitution rights are
substantive.

2. Right to obtain
substantially all of the (irrelevant)
ecnomic benefit

3. Right to direct the use (irrelevant)

THE CONTRACT DOES NOT CONTAIN A

CONCLUSIONS:
LEASE
 LEASE TERM

is “the non-cancellable period of a lease, together

with both:

a. an option to extend
b. an option to terminate
ACCOUNTING FOR
LEASES BY LESSEE
ILLUSTRATION: GENERAL RECOGNITION
On January 1, 20x1, Entity X enters into a 3-year lease of
equipment for an annual rent of P100,000 payable at the end of
each year. The equipment has a remaining useful life of 10 years.
The interest rate implicit in the lease is 10%, while the lessee’s
incremental borrowing rate is 12%. Entity X uses the straight-line
method of depreciation.
Fixed payments P100,000
Multiply by: PV of an ordinary annuity of P1 @10%, n=3 2.48685
Present value of lease payments P248,685

The entry to record the lease is as follows:

Jan. 1, 20x1 Right-of-use asset 248,685

Lease Liability 248,685
Amortization table:

Date Payment Interest Amortization Present Value

1/1/x1 248,685

12/31/x1 100,000 24,869 75,131 173,554

12/31/x2 100,000 17,355 82,645 90,909

12/31/x3 100,000 9,091 90,909 0

Cost P248, 685
Divide by: Lease term (shorter) 3
Annual depreciation P82, 895

The entries on December 31, 20x1 are as follows:

Dec. 31, 20x1 Interest expense 24, 896

Lease liability 75, 132
Cash 100,000

Dec. 31, 20x1 Depreciation expense 82, 895

 PFRS 16 (current standard)

PAS 17 (old)
Year Interest Depreciation Total
Rent expense

20x1 24,869 82, 895 107, 764 100,000

20x2 17, 355 82, 895 100, 250 100,000

20x3 9,091 82, 895 91, 986 100,000

Total expense 300,000 300,000

 A lessee may elect not to apply
the recognition requirements
Recognition exemptions described earlier (i.e., the
recognition of a lease liability and
a right-of-use asset) for:

a. Short-term leases
b. Leases for which the
underlying asset is of low value
 SHORT-TERM LOW VALUED ASSET

A short-term lease is “a lease The assessment of valued is

that, at the commencement based on the value of the
date, has a lease term of 12 asset when it is new,
months or less. A lease that regardless of the age of the
contains a purchase option is asset being leased.
not a short-term lease.”
 CLASSROOM DISCUSSION:
RECONITION EXEMPTION
4. On January 1, 20x1, Entity X enters into a 4-year lease of office
equipment. Annual rental payable at the end of each year is
P12,000. As inducement in entering into the lease, the lessor
makes the first 3 months of the lease as rent-free. Entity X opts to
use the practical expedient allowed under PFRS 16 for leases of
low value assets.
Solution:

20x1 (P12,000 x 9/12) 9,000

20x2 12,000
20x3 12,000
20x4 12,000
Total: 45,000
Divide by: Lease term 4
Annual lease expense 11, 250
Jan. 1, 20x1 No entry

Rent expense 11, 250

9,000
Dec. 31, 20x1 Cash
2, 250
Rent payable

Rent expense 11, 250

Dec. 31. 20x2 Rent payable 750
12,000
Cash

Rent expense 11, 250

Dec. 31, 20x3 Rent payable 750
12, 000
Cash

Rent expense 11, 250

Dec. 31, 20x4 Rent payable 750
12,000
Cash
• SEPARATING THE COMPONENTS OF A
CONTRACT
• LEASE OF MULTIPLE ASSETS
• NON-LEASE ELEMENTS
• PRACTICAL EXPEDIENT
• IN-SUBSTANCE FIXED LEASE PAYMENTS
• LEASE INCENTIVES
 VARIABLE LEASE PAYMENTS

Type of variable
Initial accounting Subsequent accounting
payment

• Adjust lease liability and right-of-

• Include in lease liability and
use asset when the revised index
a. Based on index or right-of-use asset based on the
or rate changes the lease
rate level of index or rate at the
payments (using the original
commencement dat.
discount rate)

• Recognized as expense when

b. Others (based on • Exclude from lease liability and
event or condition that triggers
sales or usage) right-of-use asset
payment occurs.

c In-substance fixed
• Treat as fixed lease payments • Treat as fixed lease payments
RESIDUAL VALUE
GUARANTEE
Is the guarantee made to the lessor by a party unrelated to the lessor that the
value of an underlying asset at the end of the lease term will be at least a specified
amount.

- Intermediate Accounting 2, Valix

As to the lessee, a
residual value is
guaranteed if it is:
• Guaranteed by the lessee; or

• Guaranteed by a party related to the

lessee.
• A lessee includes in the lease payments the amount expected
to be payable under the residual value guarantee.

• When a lessee recognizes a liability for a residual value, this

presupposes that the asset will revert back to the lessor at
the end of the lease term.
 Measurement of lease liability

• IFRS 16, provides that the commencement date, the lessee

shall measure the lease liability at the present value of
lease payments.

• The lease payments shall be discounted using the

interest rate implicit in the lease.

• If the implicit interest rate cannot be readily determined,

the incremental borrowing rate of the lessee is used.
 SAMPLE
PROBLEM
On Jan. 1, 20x1, ABC Co. leased a machine. Information on the
lease is as folllows:

Fixed Annual payment at the beginning of each year

Lease P
Term
50,000
4 years

Useful life of equipment

5 years
Implicit interest rate
ABC Co. has guaranteed
12% a P 15,000 residual value of which ABC Co.
expectsvalue
Present to pay
of P10,000 on lease
an ordinary expiration
annuity when
of 1 for 4 the at
periods leased asset is
reverted back to the lessor.
3.40183
12%
Present value of 1 for 4 periods at 12%
 Lease Payments PV factors @ 12%, n= 4
PV

Fixed payments 50,000 PV of an ordinary annuity of P1 3.40183

170,092

___________
Payable on guaranteed 10,000 PV of P1 0.63552
176,447
___________
_
6,355 ___________
Residual value
Journal entry: _
_

Jan. 1, 20x1 Right- of- use asset 176,447

Cash
. 50,000
Lease liability 126,447
SUBSEQUENT MEASUREMENT:
Dec. 31 20x1 Interest Expense 15,174
Lease liability 15,174

Dec. 31, 20x1 Depreciation expense 44,112

(176,447/ 4years)
Right-of-use asset 44,112

Jan. 1, 20x1 Lease liability 50,000

Cash 50,000
 NEW ACCOUNTING (PFRS 16) OLD ACCOUNTING

Only the amount expected to be payable on the The total guaranteed residual value is
residual value guarantee is included in the lease included in the lease payments regardless of
payments. the amount expected to be payable.

The residual value is not deducted when The residual value is deducted when
depreciating the right-of-use asset. depreciating the leased asset.

Changes in the expected amount to be payable The lease liability is not subsequently
on the residual value guarantee are accounted measured.
for as reassessment of the lease liability.
PURCHASE OPTION

The exercise price of purchase option is

included in the lease payments if the
exercise is reasonably certain.
 Lessee Company leased a machine on January 1, 2020 with the
following pertinent information:
Fixed rental payment at the end of each year 1,000,000
Lease term 10 years
Useful life of machine 12 years
Incremental borrowing rate 14%
Implicit interest rate 12%
Present value of an ordinary annuity of 1 for 10 periods at
14% 5.2161
12% 5.6502

Present value of 1 for 10 periods at

14% 0.2697
12% 0.3220
Lessee Company has the option to purchase the machine upon
the lease expiration on January 1, 2030 by paying P500,000.

The lessee is reasonably certain to exercise the purchase option

at the commencement date of the lease.

The estimated residual value of the machine at the end of the 12year life is
P600,000.
Required:
1.Journal entries for 2020
2. Amortization Table
3. Journal entries on January 1, 2030
a. If the lessee does exercise the purchase option
Cost of Right of Use Asset
PV of lease payment ( 1,000,000x 5.6502) 5,650,200
PV of purchase option (500,000 x 0.3220) ________161,000
Lease Liability __________
5,811,200

Journal entry:
Jan. 1, 2020 Right-of-use-asset 5,811,200
Lease liability 5,811,200

To record the acquisition of the machinery under finance lease.

2.
.
 Journal entries on December 31, 2030 are as follows:.

Dec. 31, 2030 Depreciation Expense 434,267

Accumulated Depreciation
434,267

Dec. 31, 2030 Interest expense 697,344

Lease liability
Cost
302,656
5,811,200 Cash _________
Residual value
1,000,000 (600,000)
Depreciation amount ________ 5,211,200
Divided by: Useful life ________ 12 years
Purchase option- exercised
Jan. 1, 2030
Lease liability 500,000
Cash
500,000

Purchase option- not

Jan. 1, 2030 exercised
Lease liability 500,000
Accumulated Depreciation 4,342,670
Loss on Finance Lease 968,530
Right-of-use asset
 Supporting
computation:
Right of use asset
5,811,200 ___________
Accumulated Depreciation (434 ,267 x 10yrs.)
(4,342,670)
Carrying amount ___________
1,468,530 ___________
___________

Lease liability
(500,000)
Loss on Finance Lease
968,530
INITIAL DIRECT COST

Are “ incremental costs of obtaining a lease that would not

have been incurred if the lease had not been obtained, except
for such costs incurred by a manufacturer or dealer lessor in
connection with a finance lease.
A lessee capitalizes initial direct costs as follows:

RECOGNITION
GENERAL
EXEMPTION
RECOGNITION
Treat as prepaid rent and
Treat as part of the cost of the
recognize as expense on a
right-of-use asset and include in
straight line basis.
depreciation.
Illustration- Initial Direct
On January 1, 2021, Simple Company leased an equipment with the
Cost
following information:
Annual fixed rental payment in advance at the beginning of each lease year 1,000,000
250,000
Initial direct cost paid 150,000
Lease incentive received 300,000
Residual value guaranteed 5 years
Lease term 6 years
Useful life of equipment 8%
Implicit interest rate
4.3121
Present value of an annuity of 1 in advance
at 8% for 5 periods .6806
Present value of 1 at 8% for 5 periods
 Computati
on
PV of rentals (1,000,000 x4.3121)
4,312,100
────—---
PV of residual guarantee (300,000 x.6806)
204,180

Lease liability- January 1, 2021

4,516,280 ────—---
Initial direct cost __________
250,000 _____________________________

Leasedirect
Initial incentive
cost received
(150,000)
250,000
Lease incentive received _________
Cost of right of use asset
(150,000)
4,616,280 ________-
__________________
Journal entry
Jan. 1, 2021
Right of use asset 4,616,280
Lease liability
4,516,280
 Journal entry
Jan. 1, 2021
Lease liability
1,000,000
Cash
Jan. 1, 2021
1,000,000
InterestToexpense
record the first payment on January 1, 2021
281,302
Accrued interest payable
281,302
Jan. 1, 2021
To accrue
Depreciation the interest for 2021 on December 31, 2021.
(4,316,280/5)
863,256
Accumulated depreciation
Cost 4,616,280
Residual value guaranteed (300,000)
━━━━━━

Depreciable amount 4,316,280

━━━━━━
━━━━━━
 Lease Payments made to lessor at or before
commencement date
General recognition
• Arises when rentals are payable at the beginning
Advance rent
of each period.
• Excluded from the initial measurement of lease
liability but included in the initial measurement of
right-of-use asset.
Lease Bonus • Is an additional payment made by a lessee to a lessor
to induce granting of leasehold rights to the lessee.
lease bonus is the opposite of “lease incentive”.
• Same accounting as advance rent above.
 Lease Payments made to lessor at or before
commencement date
Recognition Exemption

Advance rent • treated as prepaid rent and recognized as

expense on a straight line basis.

Lease Bonus • Same accounting as advance rent above.

 SECURITY DEPOSITS

Another form of payment made to

the lessor at or before
commencement date is security
deposit.

Are intended to compensate for

any damages caused to the leased
property.
 REASSESSMENT OF THE LEASE LIABILITY

A lessee remeasures the lease liability ( and adjusts the right-of- use asset) if there are subsequent
changes to the lease payments.
A. Change in the
lease term B. Change in the
assessment of a
The revised lease payments are purchase option
determined based on the revised The revised lease payments

lease term. shall reflect the change in the

amount payable under the
purchase option.
 The lease liability is remeasured by discounting the revised lease payments using an unchanged
discount rate if there is a:

A. Change in the residual B. Change in future lease payments

value guarantee resulting from a change in an index or
a rate used to determine those
The revised lease payments shall payments
The revised lease payments shall
reflect the change in the amount
reflect the change in the contractual
expected to be payable under the
cash floes resulting from the occurence
residual value guarantee.
of the specified event or condition.
 LEASE MODIFICATIONS
Depending on it’s nature, a lease modification is accounted for as a;

A. Separate Lease; or
B. Remeasurement of the existing lease liability and right-of-use asset.
On January 1, 2021, an entity entered into a lease agreement with the following information:
Floor space
Annual rental payable at the end of each year 3,000 sq. mtrs
100,000
Implicit rate in the lease 10%
Lease term 8 years PV of an
ordinary annuity of 1 at 10% for 8 periods 5.3349

On January 1, 2022, the entity and the lessor agreed to amend the original terms of the lease
with the following information:

Additional floor space 4,500 sq. mtrs

Increase in rental payable at the end of each year 200,000 200,000
Implicit rate in the lease 8%
PV of an ordinary annuity of 1 at 8% for 6 periods 4.6229
 Requirements:
The increase in the rental for the additional 4,500 square meters is
equivalent to the current market value.
a. Prepare journal entry to record (a) right of use asset; (b) Annual
rental payment;
(c) annual depreciation for year 2020.

b. Prepare journal entry to record (a) right of use asset; (b) Annual
rental payment; (c) annual depreciation for year 2022.
 PV of lease payments 1/1/20 (100,000 x 5.3349) = 533,490

Jan. 1, 2020
Right of use asset 533,490
Lease liability 533,490
Dec. 31, 2020
Interest expense (533,490 x 10%) 53,349
Lease liability 46,651
Cash 100,000
Dec. 31, 2020
Depreciation 66,686
Accumulated depreciation (533,490/8) 66,686
Modification
PV of the additional lease payment 1/1/22 (200,000 x 4.6229) = 924,580
Not a separate lease
A lessee accounts for a lease modification that is not a separate lease, at the
effective date of the modification by remeasuring the lease liability.

Separate lease
If both the scope and consideration in the lease are increased due to the
addition of a right to use onre or more underlying asset and the increase
reflects the stand-alone price for the increase in scope.
 Journal entries for 2022- New Separate Lease
Jan.1, 2022
Right of use asset 924,580
Lease liability 924,580

Dec. 31, 2022

Interest expense (924,580 x 8%) 73,966
Lease liability 126,034
Cash 200,000
Dec. 31,2022
Depreciation 154,097
Accumulated depreciation (924,580/6 years) 154,097
Intermediate accounting 2, Valix
Intermediate accounting 2,
Intermediate accounting 2,
LEASEHOLD IMPROVEMENTS
• A leasehold improvement is a change made to a
rental property to customize it for the particular
needs of a tenant.

PRESENTATION
• The lessee shall present the right of use asset as a separate line
item in the statement of financial position.
Intermediate Accounting 2
(Zeus Vernon B. Millan)
2023 edition

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