Mindanao State University

College of Business Administration and Accountancy

DEPARTMENT OF ACCOUNTANCY
Marawi City

FINANCE LEASE – LESSOR: DIRECT FINANCING LEASE

Accounting 122
TRUE OR FALSE. Determine whether the following statements are correct or not with regards to
direct financing leases. Write A if the statement is correct and write B if not. Final answers should
be written on the answer sheet provided with this questionnaire. Erasures are strictly not allowed.
1. The main distinction between a direct financing lease and a sales type lease is the
presence or absence of a manufacturer’s profit or loss. A
2. The gross investment in a direct financing lease is equal to the gross rentals for the entire
lease term plus the present value of the residual value whether guaranteed or not. B
3. The lessor would treat the finance lease as a receivable equal to gross amount receivable
on the lease and recognize finance payments by reducing debt and taking interest to
income statement. B
4. Initial direct costs paid by the lessor in a direct financing lease would reduce the amount
of interest income to be recognized over the lease term. A
5. The net investment in a direct financing lease is equal to the cost of the asset plus any
initial direct cost paid by the lessee. B
6. The lessor in a direct financing lease is engaged in the financing business. Thus, a direct
financing lease is an arrangement between a financing entity and a lessee. A
7. Under a direct financing lease, the excess of aggregate rentals over the cost of the lease
asset shall be recognized as income of the lessor in increasing amounts during the term of
the lease. B
8. Both direct financing and sales type leases recognize interest revenue over the lease
term. A
9. The total financial revenue of the lessor in direct financing leases is the difference
between the gross investment and the net investment in the lease. A
10. To compute for the annual rental, the procedure is to divide the “net investment in the
lease” by the present value factor of an annuity of 1 or annuity of 1 in advance for a
number of periods using a desired rate of return. B

SHORT PROBLEMS. Compute for the amount/s asked by each problem. Round off present value
factors to four decimal places. Final answers should be written on the answer sheet provided
with this questionnaire. Solutions are to be written in a separate sheet of paper to be submitted
along with the answer sheet. Erasures are strictly not allowed.
PROBLEM 1: Assimilator Controls Corporation is in the business of leasing equipment. Assimilator
purchased a new equipment on December 31, 2011. The equipment was delivered the same
day, by prior arrangement, to Tantalum Investment Company, a lessee. The corporation
accountant revealed the following information relating to the lease transaction:
Cost of equipment to Assimilator Controls P 550,000
Estimated useful life and lease term 8 years
Expected residual value – unguaranteed P 40,000
Assimilator Controls’ implicit rate of interest 12%
Tantalum’s incremental borrowing rate 14%
Date of first lease payment December 31, 2011
Additional information is as follows:
A. At the end of the lease, the equipment will revert to Assimilator Controls.
B. Tantalum is aware of Assimilator Controls’ rate of implicit interest.
C. The lease rental consists of equal annual payments.
1. Prepare the 2011 and 2012 journal entries relating to the lease on the books of Assimilator
Controls Corporation.
2. Prepare the 2011 and 2012 journal entries relating to the lease on the books of Tantalum
Investment Company.
3. Compute the total financial revenue to be recognized over the lease term. 257,600
4. What is the balance of the lessor’s net receivable at the end of 2012? 412,586
5. Assimilator Controls’ interest income for 2013 is: 49,510
6. What is the balance of the lessee’s net liability at the end of 2012? 394,491
7. Tantalum Investment’s interest expense for 2013 is: 47,339
8. The equipment’s carrying amount in the books of Tantalum Investment as of December 31,
2013 is: 400,383

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 1
PROBLEM 2: Iceberg Company is in the business of leasing a new sophisticated equipment. Such
an equipment was delivered to a lessee on January 1, 2011 under a direct financing lease.
Relevant information regarding the lease follows:
Cost of equipment P 3,454,520
Annual rental payable at the beginning of each year 600,000
Residual value – guaranteed 200,000
Initial direct cost paid by Iceberg ?
Lease term and useful life 10 years
Implicit interest rate before considering initial direct costs 12%
Implicit interest rate after considering initial direct costs 10%
The equipment will revert to Iceberg Company at the end of the lease term.
9. The initial direct costs paid by Iceberg Company is: 309,340
10. The interest income to be recognized by Iceberg Company for 2012 is: 354,025
11. Iceberg Company’s net lease receivable as of December 31, 2013 is: 3,023,698
PROBLEM 3: Camia Company is in the business of leasing new hi-tech equipment. All are
classified as direct financing lease. At the end of the lease term, the equipment will revert to
Camia Company. On January 1, 2011, an equipment was leased to another entity with the
following information:
Cost of equipment P 5,500,000
Residual value – guaranteed 400,000
Annual rental payable in advance 959,500
Useful life and lease term 8 years
First lease payment January 1, 2011
12. The interest implicit in the lease (rounded to the nearest percentage) is: 12%
13. What is the carrying amount of the net lease receivable to be presented in the December
31, 2012 statement of financial position? 4,620,963
PROBLEM 4: Oceanic Company is engaged in leasing equipment. Such an equipment was
delivered to a lessee on January 1, 2011 under a direct financing lease with the following
provisions:
Cost of equipment P 4,361,200
Unguaranteed residual value 200,000
Annual rental payable at the end of each year 800,000
Useful life and lease term ?
Implicit interest rate 10%
The equipment will revert to Oceanic upon the lease expiration.
14. What is the useful life of the equipment? 8years
15. What amount of net receivable should be presented current assets on December 31,
2012? 440,295
16. Considering your answer in No. 14, what would be the annual rental over the lease term
assuming the equipment will not revert to Oceanic? 817,485
PROBLEM 5: Ericson Company leased an asset to another entity. The cost of the asset was
P7,994,000. Terms of the lease specify 4-year life for the lease, an annual interest rate of 15% and
4 year-end rental payments. The lease qualifies as a finance lease and is classified as a direct
financing lease. The lease provides for a transfer of title to the lessee at the end of the lease
term. After the fourth year, the residual value is estimated to be P1,000,000. In negotiating and
arranging the lease, Ericson Company incurred initial direct costs of P164,360.
17. What is the annual rental payment? 2,800,000
18. The interest income of Ericson for the second year of the lease term is: 910,074
PROBLEM 6: Ondoy Company leased an asset to another entity on January 1, 2011. A third party
guaranteed the residual value of the asset under the lease, estimated to be P1,200,000 on
January 1, 2016, the end of the lease term. The lease is properly classified as a direct financing
lease. Annual lease payments are P1,000,000 due each December 31, beginning December 31,
2011. The last payment is due December 31, 2015. Both the lessor and lessee use 10% as the
interest rate. The remaining useful life of the asset is 6 years at the commencement of the lease.
19. What is the net liability balance for the lessee on December 31, 2011? 3,169,880
20. What is the net asset balance for the lessor on December 31, 2012? 3,388,415
PROBLEM 7: Macedonia Company decided to enter into a leasing business. The entity acquired
a specialized machine for P3,000,000 cash and leased it on January 1, 2011 for a period of 6
years after which the machine is returned to Macedonia Company for disposition. The expected
unguaranteed residual value of the machine is P200,000. The lease terms are arranged so that a

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 2
return of 12% is earned by Macedonia Company. The first lease payment is made January 1,
2011 and subsequent payments are made each December 31.
21. Compute the annual rental payable in advance required to yield the desired return.
22. The gain (loss) on December 31, 2016 if the machine is actually sold to the lessee for
P300,000 is:
PROBLEM 8: Cassandra Company decides to enter the leasing business. The entity acquires a
specialized packaging machine for P3,000,000 cash and leases it for a period of 6 years after
which the machine is to be returned to Cassandra Company for disposition. The guaranteed
residual value of the machine is P200,000. The lease term is arranged so that a return of 12% is
earned by Cassandra Company.
23. What is the annual rental payable in advance required to yield the desired return? 629,517
PROBLEM 9: Alpha Company buys equipment for leasing it to various manufacturing entities. On
January 1, 2011, Alpha Company leased an equipment to another entity. The cost of the
equipment to Alpha Company was P1,377,480 which approximates fair value on the lease date.
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 expected economic
life of the equipment is also 4 years. The title of the equipment remains in the hands of Alpha
Company 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 Alpha Company ends
December 31.
24. Compute the total financial revenue over the lease term.
25. The current portion of the net lease receivable on December 31, 2012 is:
26. The interest income to be recognized by Alpha Company from the lease for 2013 is:
PROBLEM 10: Glade Company leases computer equipment to customers under direct financing
leases. The equipment has no residual value at the end of the lease and the leases do not
contain bargain purchase options. Glade Company wishes to earn 8% interest on a 5 year lease
of equipment with a cost of P323,400.
27. What is the total amount of interest revenue that Glade Company will earn over the life of
the lease?

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 3