Mindanao State University

College of Business Administration and Accountancy

DEPARTMENT OF ACCOUNTANCY
Marawi City

OPERATING LEASES
Accounting 122
TRUE OR FALSE. Determine whether the following statements are correct or not with
regards to operating 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. Lease payments under an operating lease shall be recognized as an expense by the
lessee or as an income by the lessor on a straight line basis over the lease term unless
another systematic basis is representative of the time pattern in which use benefit
from the leased asset is diminished. A
2. The operating lease is the popular concept of accounting for lease and it is actually
the rental approach. A
3. A lease bonus paid by the lessee to the lessor in addition to the periodic rental is
treated as prepaid rent expense by the lessee to be amortized over the lease term. A
4. Leasehold improvement made by the lessee shall be depreciated over the life of the
improvement or lease term, whichever is longer. B
5. The residual value of the leasehold improvement is ignored by the lessee in
computing depreciation. A
6. Any security deposit refundable upon the lease expiration is accounted for as an asset
by the lessee and as a liability by the lessor. A
7. The leased property remains as an asset of the lessor and consequently, the lessor
bears all ownership or executory costs such as depreciation of leased property, real
property taxes, insurance and maintenance. However, the lessor may pass on to the
lessee the incurrence or payment of such executory costs. B
8. The depreciation policy for depreciable leased asset shall be consistent with the
lessor’s normal depreciation for similar asset. A
9. Initial direct costs incurred by the lessor in an operating lease shall be added to the
carrying amount of the leased asset and recognized as an expense over the lease
term n the same basis as the lease income. A
10. The appropriate valuation of an operating lease in the statement of financial position
of the lessee is the present value of the sum of the lease payments discounted at an
appropriate rate. B

COMPREHENSIVE PROBLEM. Compute or provide for the amount/s or journal entries

asked by the problem. Final answers should be written on the answer sheet provided with
this questionnaire. Solutions are to be written in a separate sheet of paper. Erasures are
strictly not allowed:
O-“BEE”-RATING LEASE
On January 1, 2011, Bee Company purchased a building for P6,000,000 cash for the purpose
of leasing it. The building is expected to have a 10-year life and no residual value. On April 1,
2011, Bee Company leased the building to Aye Company for three years beginning
immediately. Under the terms of the operating lease, Aye will pay a monthly rental of
P90,000 payable in advance. However, as an inducement to enter the lease, Bee granted
Aye the first 6 months of the lease rent-free.
On the same date, April 1, 2011, Bee received a security deposit from Aye of P600,000 to be
refunded upon the lease expiration. In addition to the rental, Bee Company received from
Aye a lease bonus of P120,000 on April 1, 2011. In negotiating and arranging the operating
lease, Bee paid initial direct costs of P300,000.
On January 1, 2012, Aye Company finished constructing an improvement in the rented
building at a total cost of P500,000. Such leasehold improvement is expected to be useful
for 5 years with a residual value of P50,000 at the end of its life. During each year over the
lease term, Bee Company paid repairs and maintenance expenses of P15,000. Based on the
foregoing information, answer the following questions:
1. Prepare all the entries on the books of the lessor in 2011 and 2012.
2. Prepare all the entries on the books of the lessee in 2011 and 2012.
3. The annual rent expense of Aye would be: 40, 000
4. The annual depreciation on the leasehold improvement made by Aye would be:
222,222
5. The building of Bee would be carried in the financial statements on December 31, 2012
at: 4,925,000
6. Aye would recognize a rent payable on December 31, 2011 of: 405,000

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 1
 7. Bee would recognize a rent receivable on December 31, 2012 of: 225,000
8. Aye would recognize on December 31, 2012 total assets relating to the lease of:
927,778
9. Bee would recognize on December 31, 2012 total assets relating to the lease of:
5,150,000
10. Bee’s annual net rent income is: 225,000

SHORT PROBLEMS. Compute for the amount/s asked by each problem. 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: Vim Company purchased an equipment on January 1, 2011 for P3,000,000
cash for the purpose of leasing it. The machine is expected to have a 10 year life from the
date of purchase. On April 1, 2011, the equipment was leased to Eloisa Company for a 3
year period at a monthly rental of P40,000 payable at the end every month. Additionally,
Eloisa Company paid P120,000 to Vim Company on April 1, 2011 as a lease bonus. Vim
Company paid repairs of P20,000 relating to 2011.
1. Compute the net rent income of the lessor for 2011. 70,000
PROBLEM 2: On March 20, 2011, Barnes Company purchased a machine for P2,400,000 for
the purpose of leasing it to others. The machine is expected to have a 10 year life and no
residual value. It will be depreciated on the straight line base computed to the nearest
month. The machine was leased to Rally Company on April 1, 2011 for 4 years at a monthly
rental of P36,000. Barnes Company paid P120,000 initial direct costs associated with
negotiating the lease in March 2011.
2. The machinery would be reported in the financial statements on December 31, 2011
at: 2,713,000
PROBLEM 3: On December 1, 2011, Tell Company leased office space for 5 years at a
monthly rental of P60,000. On the same date, Tell Company paid the lessor the following
amounts:
Bonus to obtain lease P 500,000
First month’s rent 60,000
Last month’s rent 60,000
Security deposit refundable at lease expiration 80,000
Intstallation of new walls and offices 360,000
3. In its income statement ended December 31, 2011, what amount should Tell Company
report as rent expense? 68,333
PROBLEM 4: On July 1, 2011, Walton Company leased office premises for a 3 year period at
an annual rental of P360,000 payable on July 1 of each year. The first rent payment was
made July 1, 2011. Additionally, on July 1, 2011, Walton Company paid P240,000 as a lease
bonus to obtain a 3 year lease instead of the lessor’s usual term of 6 years.
4. In the December 31, 2011 statement of financial position, what should be reported as
prepaid rent? 380,000
PROBLEM 5: As an incentive to enter a 4 year operating lease for a warehouse, Dunhill
Company received an upfront cash of P60,000 upon signing an agreement on January 1,
2011.The annual rental is P1,115,000. In addition, Dunhill was allowed to occupy the
warehouse rent free for a period of 4 months.
5. How much should be recognized by Dunhill as lease expense for 2011? 1,007,083
PROBLEM 6: Conn Company owns an office building and normally charges tenants P3,000
per square meter per year per office space. Because the occupancy rate is low, Conn
Company agreed to lease 1,000 square meters to Hanson Company at P1,200 per square
meter for the first year of a 3 year operating lease. Rent for remaining years will be at the
P3,000 rate. Hanson moved into the building and paid the first year’s rent in advance on
January 1, 2011.
6. What amount of rental revenue should Conn Company report in its income statement
for the year ended October 31, 2011? 2,000,000
PROBLEM 7: Wall Company leased office premises to Fox Company for a 5 year term
beginning January 1, 2011. Under the terms of the operating lease, rent for the first year is
P800,000 and rent for years 2 through to 5 is P1,250,000 per annum. However, as an
inducement to enter the lease, Wall Company granted Fox Company the first 3 months of
the lease rent free.

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 2
 7. In its December 31, 2011 income statement, what amount should Wall Company
report as rental income? 1,120,000
8. In its December 31, 2011 statement of financial position, what amount should Wall
Company report as rent receivable? 520,000
PROBLEM 8: On January 1, 2011, Ehr Company leased a building to Dent Corporation for a
ten-year term at an annual rental of P60,000. At inception of the lease, Ehr received
P240,000 covering the first two years' rent of P120,000 and a security deposit of P120,000.
This deposit will not be returned to Dent upon expiration of the lease but will be applied to
payment of rent for the last two years of the lease.
9. What portion of the P240,000 should be shown as a non-current liability in Ehr's
December 31, 2011 balance sheet? 60,000
PROBLEM 9: Dorey Company purchased a machine on January 1, 2011 for P5,000,000 for
the express purpose of leasing it. The machine was expected to have a 10 year life with no
residual value and is to be depreciated on a straight line basis. On March 1, 2011, Dorey
Company leased the machine to Anne for P1,200,000 a year for a 4 year period ending
February 28, 2015. Dorey Company paid a total of P60,000 for maintenance expenses and
received P1,400,000 from Anne on March 1, 2011 including payment for property taxes and
insurance passed on to Anne. In relation to the lease, Dorey paid P12,000 to a real estate
broker as a finder’s fee on February 25, 2011. Dorey Company retains title to the property
and plans to lease it to someone else after the 4 year lease period.
11. Determine the net rent income of Dorey Company for 2011.
12. What is the carrying amount of the machine as of December 31, 2012?
PROBLEM 10: Manila Company is engaged in leasing heavy equipment. On January 1,
2011, the entity bought a second hand heavy equipment for P375,000. In January 2011, the
entity incurred P75,000 for a major overhaul to put the equipment in good running condition.
The equipment is available for the intended use on March 1, 2011. The equipment has an
estimated useful life of 5 years. Depreciation is on a straight line basis. On April 1, 2011,
Manila Company leased the equipment to Makati Company for 2 years up to March 31, 2013.
The lease fee is P15,000 for one year. On the same date, Manila received P48,000 as a lease
bonus from Makati. During 2011, Manila spent P7,000 for minor repairs and P3,000 for
transportation of the equipment to Makati Company.
13. The total expenses to be recognized in 2011 from the lease is:
14. The total rent income of Manila Company for 2013 is:
PROBLEM 11: Maita Company leases some of the equipment it uses. The lease term is 5
years and the lease payments are to be made in advance as shown in the following
schedule:
January 1, 2011 P 300,000
January 1, 2012 300,000
January 1, 2013 450,000
January 1, 2014 550,000
January 1, 2015 700,000
15. The amount of rent receivable Maita would report as of December 31, 2013 is:
16. Assuming Maita’s year end is March 31, the amount of rent receivable Maita would
report as of March 31, 2012 is:
PROBLEM 12: Kew Company leases and operates a retail store. The following information
relates to the lease for the year ended December 31, 2011:
A. The store lease, an operating lease, calls for a base monthly rent of P15,000 on the
first day of each month.
B. Additional rent is computed at 5% of net sales over P3,000,000 up to P6,000,000 and
6% of net sales over P6,000,000 per calendar year but the additional rent per
calendar year should not to exceed P300,000. Net sales for 2011 amounted to
P9,000,000.
C. Kew Company paid executory costs to the lessor for property taxes of P120,000 and
insurance of P50,000.
17. What total amount of expenses relating to the store lease should be reported for 2011?
PROBLEM 13: On July 1, 2011, Kemp Company leased office space for five years at
P300,000 a month. On that date, Kemp Company paid the lessor the following amounts:
Rent security deposit P 700,000
First month’s rent 300,000
Last month’s rent 300,000
Non-refundable reimbursement to lessor for
modifications to the leased premises 1,800,000

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 3
Kemp Company made timely rental payments from August 1 through December 1, 2011.
18. What portion of payments to the lessor should Kemp Company have recognized as
deferred to years beyond 2011?
PROBLEM 14: Barnel Company owns and manages apartment complexes. On signing a
lease, each tenant must pay first the last month’s rent and a P50,000 refundable security
deposit. The security deposits are rarely refunded in total because cleaning costs of P15,000
per apartment are almost always deducted. About 30% of the time, the tenants are also
charged for damages to the apartment which typically cost P10,000 to repair.
19. If a one-year lease is signed on a P90,000 per month apartment, what amount should
Barnel report as refundable security deposit?
PROBLEM 15: On January 1, 2011, Simplex Company leased a machine to another entity
for a four year-period. The annual rentals will be paid by the lessee beginning December 31,
2011. The lease agreement called for a 10% increase in annual rental per annum. The rental
due on December 31, 2014 was P266,200.
20. What is the rental income for the year ended December 31, 2011?
21. What is the rent receivable of Simplex Company as of December 31, 2012?

Prepared by: Mohammad Muariff S. Balang, CPA, Second Semester, AY 2012-2013 Page | 4