Intermediate Accounting 2

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What to discuss

I. Review:
1. Essential characteristics of a liability
2. Measurement of Liabilities
3. Classification of Liabilities
4. Presentation of Liabilities
5. Examples of Liabilities
II. Application (Illustration and Exercises) / Other Liabilities
I. Estimated Liabilities/ Deferred or Unearned Revenue
Current and Noncurrent liabilities
Long-term service contracts
Gift certificates payable
Subscriptions
Bonus Computation
Refundable deposits

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What to discuss

II. Compound Financial Instrument

III. Debt Restructure

IV. Lease Accounting

V. Other Estimated Liabilities – Premium & Warranty Liability

VI. Income Tax

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What to discuss

VII. Employment Benefits

Effective Interest Method

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Lease

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Lease

 Accounting for Lessee

o Finance Lease
“All leases shall be accounted for by the lessee as a finance lease under IFRS 16”

o Operating lease – periodic rental is simply accounted for as rent expense

 Accounting for Lessor

o Operating Lease
o Finance Lease
• Direct Financing lease
• Sales Type Lease

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Lease

• A contract or part of a contract that conveys the right to use the

underlying asset for a period of time in exchange for consideration
(IFRS 16, Appendix A)

• A contract must convey the right to control the use of an identified

asset. Right to control means that throughout the period of use, the
customer has the right to the following:
a. Obtain substantially all of the economic benefits from the use of the
identified asset
b. Direct use of the identified asset

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Lease (cont)

 Lessee – the entity that obtains the right to use an underlying asset
for a period of time in exchange for a consideration
 Lessor – the entity that provides the right to use an underlying
asset for a period of time in exchange for a consideration
 Underlying asset – the subject of a lease for which the right to use
that asset has been provided by the lessor to the lessee
 Operating Lease – a lease that does not transfer substantially all
the risks and rewards incidental to ownership of an underlying asset
 Finance Lease – a lease that transfers substantially all the risks
and rewards incidental to ownership of an underlying asset

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Lease (cont)

When is a lease classified as Finance Lease?

Any of the following situations would normally lead to a lease being
classified as a finance lease by the lessor:
a. The lease transfers ownership of the underlying asset to the lessee at the
end of the lease term

b. The lessee has an option to purchase the asset at a price which is expected
to be sufficiently lower than the fair value at the date the option becomes
exercisable. At the inception of the lease, it is reasonably certain that the
option will be exercised.

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Lease (c0nt)

When is a lease classified as Finance Lease?

Any of the following situations would normally lead to a lease being
classified as a finance lease by the lessor:
c. The lease term is for the major part of the economic life of the underlying
asset even it title is not transferred.

d. The present value of the lease payments amounts to substantially all of the
fair value of the underlying asset at the inception of the lease.

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Lease (cont)

Other criteria suggestive of a Finance Lease

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

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Lease (accounting on the part of the lessee)

1. Recognition - the following accounts are used:

a. Right of use asset = the right to use the underlying asset
over the lease term
b. Lease Liability = the obligation to make payments
2. Initial Measurement
a. Right of use asset
• Measure the right of use asset at commencement date at cost
• Cost of right of use asset is comprised of the items shown in next
slide

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Lease (accounting on the part of the lessee)

Cost of right of use asset:

a. Present value of lease payments or the initial measurement of the lease
liability
b. Lease payments made to lessor at or before commencement date (lease
bonus), less any lease incentives1 received
c. Initial direct costs incurred by the lessee
d. Estimate of cost of dismantling, removing and restoring the underlying
asset for which the lessee has a present obligation

1Lease incentives – payments by the lessor to the lessee associated with a lease; or reimbursement; or
assumption by the lessor of the costs of the lease (e.g. lessor agrees to reimburse the lessee for the
commission paid by the lessee to a broker)

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Take note:
• 1. Leasehold improvements
• Not initial direct costs & not included in the cost of the right of use asset
• Separately accounted for as PPE and depreciated over the shorter between the
lease term and the life of the improvements

• 2. Any security deposit refundable upon the lease expiration is accounted for as an
asset by the lessee

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Lease (accounting on the part of the lessee)

3. Subsequent Measurement
• Measure the right of use asset applying the cost model:

Cost less accumulated depreciation and impairment loss

(If other measurement models are used, see page 319)

• Carrying amount of the right of use asset is adjusted for any

remeasurement of the lease liability

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Lease (accounting on the part of the lessee)

4. Presentation of right of use asset

• Separate line item in the Statement of Financial Position, or

• As an alternative, in the appropriate line item within which the

corresponding underlying asset would be presented if owned (e.g.
Property, Plant and Equipment). Here disclosure is required.
5. Depreciation of right of use asset
• Apply normal depreciation policy
• Use the useful life of the underlying asset if:
a. Lease transfers the ownership of the underlying asset to the lessee
at the end of the lease term
b. The lessee is reasonably certain to exercise a purchase option

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Lease (accounting on the part of the lessee)

5. Depreciation of right of use asset

• Use the shorter between the useful life of the underlying asset and the

lease term if:

a. There is no transfer of ownership of the underlying asset to the
lessee, or,
b. The purchase option is not reasonably certain to be exercised

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Lease (accounting on the part of the lessee)

b. Measurement of Lease Liability

• Measure at present value of lease payments
• Lease payments shall be discounted using the interest rate implicit in the
lease. If it cannot be determined, use the incremental borrowing rate of the
lessee

 interest rate implicit in the lease is the interest rate that causes the
present value of the lease payments and the unguaranteed residual
value to equal the fair value of the underlying asset and initial direct
costs of the lessor

 incremental borrowing rate of the lessee is the rate of interest that

the lessee would have to pay to borrow funds necessary to obtain a
similar asset over a similar term and similar security

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Lease (accounting on the part of the lessee)

Components of lease payments:

a. Fixed lease payments
b. Variable lease payments
c. Exercise price of a purchase option if the lessee is reasonably certain to
exercise the option
d. Amount expected to be payable by the lessee under a residual value
guarantee
e. Termination penalties if the lease term reflects the exercise of a
termination option
See details on fixed and variable payments on page 321

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Lease (accounting on the part of the lessee)

1. Illustration on page 342-325

2. Exercise:
o Problem 10-1, page 339 Mixx Company
o Problem 10-3, page 341 Letty Company (w/ purchase option)
o Problem 10-4, page 341 Veronica Company (w/ leasehold improvement)
o Problem 10-7, page 344 Eden Company (residual value, reimbursement)
o Problem 10-29, page 358 Yemen company
o Problem 10-30, page 359 Southstar Company

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Prob 10-1 lessee

Requirement 1
2020 Right of use asset (800,000 x 4.17) 3,336,000
Jan 1 Lease liability 3,336,000
Right of use asset 100,000
Cash 100,000
Lease liability 800,000
Cash 800,000
Dec Depreciation (3,436,000/5 yrs) 687,200
31 Accumulated depreciation 687,200
Interest expense 253,600
Accrued interest payable 253,600
Taxes 40,000
Cash 40,000

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Prob 10-1 lessee

Year Payment 10% interest Principal Present value

1/1/2020 3,336,000
1/1/2020 800,000 - 800,000 2,536,000
1/1/2021 800,000 253,600 546,400 1,989,600
1/1/2022 800,000 198,960 601,040 1,388,560

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Prob 10-1 lessee

2021 Accrued interest payable 253,600

Jan 1 Lease liability 546,400
Cash 800,000
Dec Depreciation 687,200
31 Accumulated Depreciation 687,200
Interest expense 198,960
Accrued interest payable 198,960
Taxes 40,000
Cash 40,000
Requirement 2: Entry upon expiration of the lease
2025
Jan 1 Accumulated Depreciation 3,436,000
Right of use asset 3,436,000

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Prob 10-3 lessee (purchase option)

2020 Right of use asset 6,392,400

Jan 1 Lease liability 6,392,400

PV of rentals (1M x 6.328) 6,328,000

PV of purchase option (200,000 x .322) 64,400
6,392,400
Lease Liability 1,000,000
Cash 1,000,000
Dec Depreciation (6,392,400/15) 426,160
31 Accumulated depreciation 426,160
Interest expense 647,088
Accrued interest payable 647,088

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Prob 10-3

Year Payment 10% interest Principal Present value

1/1/2020 6,392,400
1/1/2020 1,000,000 - 1,000,000 5,392,400
1/1/2021 1,000,000 647,088 352,912 5,039,488
1/1/2022 1,000,000 604,739 395,261 4,644,277

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Prob 10-3

2021 Accrued interest payable 647,088

Jan 1 Lease liability 352,912
Cash 1,000,000
Dec Depreciation 426,160
31 Accumulated Depreciation 426,160
Interest expense 604,739
Accrued interest payable 604,739

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Prob 10-4 lessee (leasehold improvement)

1 Right of use asset (1M x 7.606) 7,606,000

Lease liability 7,606,000
2 Leasehold improvement 600,000
Cash 600,000
3 Right of use asset 644,000
Estimated liability for restoration 644,000
4 Depreciation (8,250,000/15) 550,000
Accumulated Depreciation 550,000
5 Depreciation – improvement (600,000/5) 120,000
Accumulated depreciation 120,000
6 Interest expense (10% x 7,606,000) 760,600
Lease liability 239,400
Cash 1,000,000

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Prob 10-7
Requirement 1
PV of rentals (420,000-20,000 x 3.6243) 1,449,720
PV of guaranteed residua value
(200,000 x .7629) 152,580
Total present value 1,602,300

Date Payment Interest Principal PV

12/31/2020 1,602,300
12/31/2020 400,000 - 400,000 1,202,300
12/31/2021 400,000 84,161 315,839 886,461
12/31/2022 400,000 62,052 337,948 548,513
12/31/2023 400,000 38,396 361,604 186,909
12/31/2024 400,000 13,091 186,909 -

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Prob 10-7
Requirement 2
2020 Right of use asset 1,602,300
Dec Lease liability 1,602,300
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Prepaid insurance 20,000
Lease liability 400,000
Cash 420,000
2021 Insurance expense 20,000
Jan 1 Prepaid insurance 20,000
Dec Prepaid insurance 20,000
31 Interest expense 84,161
Lease liability 315,839
Cash 420,000
Depreciation 350,575
Accumulated depreciation 350,575
(1,602,300-200,000/4)
Residual value guarantee of P200,000 is deducted from the cost to get the depreciable
amount. 29
Prob 10-7
Requirement 3
2024 Accumulated depreciation (350,575x4) 1,402,300
Dec Interest expense 13,091
31 Lease liability 186,909
right of use asset 1,602,300
Loss on finance lease 150,000
Cash 150,000

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Prob 10-29
Answer A
Right of use asset – Jan 1 2020 4,800,000
Accumulated depre –Jan 1 2026
(4,800,000-300,000/8 yrs x 6 yrs) (3,375,000)
Carrying amount – Jan 1 2026 1,425,000
Lease liability –Jan 1 2026 (purch option) (100,000)
Loss on finance lease 1,325,000
The entry to record the return of the asset to the lessor as a result of the
nonexercise of the purchase option is as follows:
Accumulated depreciation 3,375,000
Lease liability 100,000
Loss on finance lease 1,325,000
right of use of asset 4,800,000
On January 1, 2026, the balance of the lease liability is equal to the purchase
option of P100,000. If the purchase option is not exercised, a loss is recognized
equal to the difference between the carrying amount of the asset and the lease
liability
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Prob 10-30
Question 1: Answer B (1M x 4.31) P4,310,000
Question 2: Answer B
Lease liability 4,310,000
Initial direct cost 350,000
Lease incentive received (150,000)
Lease bonus 100,000
Cost of restoration 200,000
Cost of right of use asset 4,810,000
Question 3: Answer C
Annual depreciation (4,810,000 / 5 yrs) 962,000
Question 4: answer C
Date Payment 8% interest Principal Lease liability
1/1/2020 4,310,000
1/1/2020 1,000,000 - 1,000,000 3,310,000
1/1/2021 1,000,000 264,800 735,200 2,574,800
1/1/2022 1,000,000 205,984 794,016 1,780,784
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END

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