PROBLEM NO.

1 Finance lease Direct financing In connection with your audit Billy Enterprises, you noted that the company has a long-standing policy of acquiring company equipment by leasing. Early in 2012, the company entered into a lease for a new milling machine. The lease stipulates that annual payments will be made for 5 years. The payments are to be made in advance on December 31 of each year. At the end of the 5-year period, Billy may purchase the machine. The estimated economic life of the equipment is 12 years. Billy uses the calendar year for reporting purposes and straight-line depreciation for other equipment. In addition, the following information about the lease is also available: Annual lease payments (including executory costs of P5,000) Purchase option price Estimated fair value of machine after 5 years Implicit rate Date of first lease payment QUESTIONS: Based on the foregoing and the result of your audit, compute for the following: (Round off present value factors to four decimal places.) 1. Amount to be capitalized as an asset for the lease of the milling machine. a. P229,345 c. P244,868 b. P224,017 d. P275,913 2. Liability under finance lease as of December 31, 2012 a. P130,919 c. P136,780 b. P153,855 d. P189,868 3. Amount to be reported under current liabilities as liability under finance lease as of December 31, 2012 a. P39,614 c. P41,908 b. P41,322 d. P36,013 4. Interest expense for the year 2012 a. P17,435 b. P18,987 c. P16,902 d. P 0 P60,000 P25,000 P75,000 10% Jan. 1, 2012

5. Depreciation expense for the year 2012 a. P20,406 c. P18,668 b. P19,112 d. P48,974 Answers: 1) C; 2) B; 3) A; 4) B, 5) A Suggested Solution: Question No. 1 Present value of rental payments (P55,000 x 4.1699) Present value of purchase option (P25,000 x 0.6209) Present value of MLP (Cost of asset) P229,345 15,523 P244,868

At the commencement of the lease term, a lessee shall recognize finance leases as assets and liabilities in its statement of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is

the interest rate implicit in the lease, if this is practicable to determine; if not, the lessees incremental borrowing rate shall be used. (PAS 17 par. 20) Minimum lease payments are the payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with: (a) for a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or (b) for a lessor, any residual value guaranteed to the lessor by: (i) the lessee; (ii) a party related to the lessee; or (iii) a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it. Question No. 2 Finance lease liability, 1/1/2012 Less lease payment, 1/1/2012 Balance, 1/1/2012 Less principal payment 12/31/2012: Total payment in 2012 Less applicable to interest (P189,868 x 10%) Balance, 12/31/2012 Question No. 3 Rental payment in 2013 Less applicable to interest (P153,855 x 10%) Current portion of finance lease liability Question No. 4 Interest expense in 2012 (see no. 2) Question No. 5 Depreciation expense in 2012 (P244,868/12) PROBLEM NO. 2 Finance lease Sales type Fernan Incorporated uses leases as a method of selling its products. In early 2011, Fernan completed construction of a passenger ferry for use between Quiapo and Guadalupe. On April 1, 2011, the ferry was leased to the Talion Ferry line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. The ferry is expected to be economically useful for 25 years. Annual lease payments do not include executory costs. Other terms of the agreement are as follows: Original cost of the ferry Lease payments Estimated residual value Implicit rate Date of first lease payment P1,500,000 P225,000 P78,000 10% April 1, 2011 P20,406 P18,987 P55,000 15,386 P39,614 P244,868 55,000 189,868 on P55,000 18,987 36,013 P153,855

Lease period PV of an ordinary annuity of 1 for 20 periods at 10% PV of an annuity due of 1 for 20 periods at 10% PV of 1 for 20 periods at 10% QUESTIONS:

20 years 8.5136 9.3649 0.1486

Based on the above and the result of your audit, determine the following. 1. Total finance income that will be earned by the lessor over the lease term a. P2,459,306 c. P2,392,897 b. P2,650,849 d. P2,584,440 2. The profit on sale to be recognized by the lessor a. P607,103 c. P415,560 b. P427,151 d. P618,694 3. Liability under finance lease to be reported by the lessee as of December 31, 2012 a. P1,634,616 c. P1,858,063 b. P1,845,313 d. P1,647,366 4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of December 31, 2012 a. P61,538 c. P40,469 b. P39,194 d. P60,263 5. Depreciation expense to be recognized by the lessee for the year 2011 a. P61,221 c. P76,091 b. P55,127 d. P60,873

Answers: 1) C; 2) A; 3) B; 4) C, 5) D

Suggested Solution: Question No. 1 Gross investment in the lease (P225,000 x 20) Net investment in the lease (P225,000 x 9.3649) Total finance income P4,500,000 2,107,103 P2,392,897

The unguaranteed residual value was not included in the computation of the minimum lease payments since the leased asset will be not revert to the lessor. Question No. 2 Sales (present value of MLP) Less cost of sales Profit on sale Question No. 3 Finance lease liability, 4/1/2011 Less lease payment, 4/1/2011 Balance, 4/1/2011 P2,107,103 225,000 1,882,103 P2,107,103 1,500,000 P 607,103

Less principal payment on 4/1/2012: Total payment in 2012 Less applicable to interest (P1,882,103 x 10%) Balance, 12/31/2012 Question No. 4

P225,000 188,210 36,790 P1,845,313

Rental payment in 2013 Less applicable to interest (P1,845,313 x 10%) Current portion of finance lease liability Question No. 5 Depreciation expense in 2011 [(P2,107,103 P78,000) x 1/25 x 9/12]

P250,000 184,531 P 40,469

P60,873

PROBLEM NO. 3 Finance lease Sales type Talion Inc. leases equipment to its customers under noncancelable leases. On January 1, 2012, Talion leased equipment costing P4,000,000 to Quezon Co., for nine years. The rental cost was P440,000 payable in advance semiannually (January 1 and July 1), plus P20,000 semiannually for executory costs. The equipment had an estimated life of 15 years and sold for P5,330,250 with an estimated unguaranteed residual value of P800,000. The implicit interest rate is 12 percent. QUESTIONS: Based on the foregoing and the result of your audit, compute for the following: (Round off present value factors to four decimal places.) 1. How much is the total interest income from lease that will be earned by Talion, Inc.? a. P2,869,988 c. P3,675,616 b. P3,389,748 d. P 0 2. Talion, Inc. should report profit on the sale at a. P1,330,252 c. P1,050,012 b. P1,044,384 d. P1,338,492 3. How much should be reported by Quezon Co. as liability under finance lease as of December 31, 2012? a. P4,143,593 c. P4,273,410 b. P4,446,613 d. P 0 4. How much should be reported by Quezon Co. under current liabilities as liability under finance lease as of December 31, 2012? a. P356,798 c. P394,252 b. P378,207 d. P 0 5. How much interest expense should be reported by Quezon Co. in relation to the lease for the year ended December 31, 2012? a. P508,064 c. P543,398 b. P501,793 d. P 0

Answers: 1) B; 2) A; 3) B; 4) A, 5) C Suggested Solution: Question No. 1 Gross investment in the lease: Minimum lease payments (P440,000 x 18) Unguaranteed residual value Net investment in the lease: PV of minimum lease payments (P440,000 x 11.4773) PV of unguaranteed residual value (P800,000 x 0.3503) Total unearned interest income Question No. 2 Sales (present value of MLP) Less cost of sales (P4,000,000 - P280,240) Profit on sale Question No. 3 Finance lease liability (P440,000 x 11.4773) Less lease payment, 1/1/2012 Balance, 1/1/2012 Less principal payment on 7/1/2012: Total payment P440,000 Applicable to interest (P4,610,012 x 12% x 6/12) 276,601 Balance, 12/31/2012 P5,050,012 440,000 4,610,012 P5,050,012 3,719,760 P1,330,252 P7,920,00 800,000 5,050,012 280,240 5,330,252 P3,389,748 P8,720,000

163,399 P4,446,613

The lease shall be accounted for as finance lease because the present value of the minimum lease payments amount to substantially all of the fair value of the leased asset at the inception of the lease. (P5,050,012/P5,330,250 = 95%).

Question No. 4 Principal payment due, 1/1/2013: Total payment Applicable to interest (P4,446,613 x 12% x 6/12) Principal payment due, 7/1/2013: Total payment Applicable to interest
[(P4,446,613 - P173,203) x 12% x 6/12]

P440,000 266,797 P440,000 256,405 183,595 P356,798 P173,203

Current portion of finance lease liability, 12/31/2012 Question No. 5 1/1/2012 to 6/30/2012 (P4,610,012 x 12% x 6/12)

P276,601

7/1/2012 to 12/31/2012 (P4,446,613 x 12% x 6/12) Total interest expense PROBLEM NO. 4 Sale and lease back

266,797 P543,398

Robes Co. purchases land and constructs a service station and car wash for a total of P6,750,000. At January 2, 2012, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for P7,500,000 and immediately leased from the oil company by Robes. Fair value of the land at time of the sale was P750,000. The lease is a 10-year, noncancelable lease. The agreement requires equal rental payments at the end of each year beginning December 31, 2012. The interest rate implicit in the lease is 10%. Robes uses straightline depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Robes at termination of the lease. QUESTIONS: Based on the above and the result of your audit, answer the following: (Round off present value factors to four decimal places) 1. The amount of annual lease payment is a. P1,098,526 c. P 976,467 b. P1,220,584 d. P1,109,632 2. The total lease-related expenses to be recognized by the lessee during 2012 is a. P1,000,000 c. P1,075,000 b. P1,425,000 d. P1,200,000 3. The total lease-related income to be recognized by the lessee during 2012 is a. P75,000 c. P750,000 b. P50,000 d. P 0 4. The total lease-related income to be recognized by the lessor during 2012 is a. P675,000 c. P750,000 b. P600,000 d. P 0 5. The amount to be reported under current liabilities as liability under finance lease as of December 31, 2012 is a. P517,642 c. P414,114 b. P470,595 d. P465,879 Answers: 1) B; 2) D; 3) A; 4) C, 5) A Suggested Solution: Question No. 1 Cost of facility (purchase price) Divide by (PV of ordinary annuity of P1 at 10% for 10 periods) Annual lease payment Question No. 2 Interest expense (P7,500,000 x 10%) Depreciation expense (P7,500,000 - P750,000/15) P 750,000 450,000 P7,500,000 6.1446 P1,220,584

Total

P1,200,000

Question No. 3 Selling price Less cost of facility Gain on sale and leaseback Divide by lease term Gain to be recognized in 2012 P7,500,000 6,750,000 750,000 10 P 75,000

If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be deferred and amortized over the lease term. (PAS 17 par. 59) Question No. 4 Interest income in 2012 (P7,500,000 x 10%) Question No. 5 Finance lease liability, 1/2/2012 Less principal payment 12/31/2012: Total payment in 2012 Less applicable to interest (P7,500,000 x 10%) Balance, 12/31/2012 P7,500,000 on P1,220,584 750,000 470,584 P7,029,416 P1,220,584 702,942 P 517,642 P750,000

Rental payment in 2013 Less applicable to interest (P7,029,416 x 10%) Current portion of finance lease liability

PROBLEM NO. 5 Pension

You gathered the following information related to Robes Companys the defined benefit plan for the year ended December 31, 2012: Current service cost of providing benefits for the year to December 31, 2012: P54 million Average remaining working life of employees: 10 years Benefits paid to retired employees in the year: P55.8 million Contributions paid to the fund: P37.8 million Present value of obligation to provide benefits: P3,960 million at January 1, 2012, and P4,500 million at December 31, 2012 Fair value of plan assets: P3,780 million at January 1, 2012, and P4,320 million at December 31, 2012 Net cumulative unrecognized gains at January 1, 2012: P453.6 million Past service cost: P207 million. All of these benefits have vested. Discount rates and expected rates of return on plan assets:

Discount rate Expected rate of return on plan assets

QUESTIONS:

1/1/2012 5% 7%

1/1/2013 6% 8%

Based on the above and the result of your audit, answer the following: 1. The amount to be recognized in the statement of financial position as of January 1, 2012 is a. P633.6 million c. P957.6 million b. P453.6 million d. P455.4 million 2. The amount of actuarial gain to be recognized in profit or loss for the year ended December 31, 2012 is a. P7.20 million c. P3.60 million b. P5.76 million d. P 0 3. The net pension expense to be recognized in profit or loss for the year ended December 31, 2012 is a. P188.64 million c. P 3.60 million b. P183.60 million d. P270.00 million 4. The unrecognized actuarial gain as of December 31, 2012 is a. P448.20 million c. P604.44 million b. P453.60 million d. P 0 5. The amount to be recognized in the statement of financial position as of December 31, 2012 is a. P784.44 million c. P180.00 million b. P682.20 million d. P455.40 million

Answers: 1) A; 2) B; 3) A; 4) C, 5) A Suggested Solution: Question No. 1 Debit Fair value of plan assets, 1/1/2012 Credits Present value of obligation, 1/1/2012 Net cumulative unrecognized gains, 1/1/2012 Prepaid (Accrued) pension expense, 1/1/2012 Question No. 2 Net cumulative unrecognized gains, 1/1/2012 Less corridor (P3,960 million x 10%) Excess Divide by average remaining working life of employees Amount to be recognized in profit or loss Question No. 3 Current service cost P 54.00 P453.60 396.00 57.60 P 10 5.76 P3,780.0 P3,960.0 453.6 4,413.6 (P 633.6)

Interest cost (P3,960 million x 5%) Expected return on plan assets (P3,780 million x 7%) Past service cost Actuarial gain recognized (see no. 2) Net pension expense Question No. 4 Net cumulative unrecognized gains, 1/1/2012 Actuarial loss on obligation (see computation) Actuarial gain on plan assets (see computation) Actuarial gain recognized (see no. 2) Net cumulative unrecognized gains, 12/31/2012 Actuarial loss on obligation Present value of obligation, 1/1/2012 Current service cost Interest cost (P3,960 million x 5%) Past service cost Benefits paid Actuarial loss on obligation (squeeze) Present value of obligation, 12/31/2012

198.00 (264.60) 207 ( 5.76) P188.64

P453.60 (136.80) 293.40 ( 5.76) P604.44

P3,960.00 54.00 198.00 207.00 ( 55.80) 136.80 P 4,500

Actuarial gain on plan assets Fair value of plan assets, 1/1/2012 Expected return on plan assets (P3,780 million x 7%) Contributions to the plan Benefits paid to retirees Actuarial gain on plan assets (squeeze) Fair value of plan assets, 12/31/2012 Question No. 5 Debit Fair value of plan assets, 12/31/2012 Credits Present value of obligation, 12/31/2012 Net cumulative unrecognized gains, 12/31/2012 Prepaid (Accrued) pension expense, 12/31/2012 PROBLEM NO. 6 Pension P4,320.00 P4,500.00 604.44 5,104.44 ( P784.44) P3,780.00 264.60 37.80 ( 55.80) 293.40 P 4,320

The following information relates to the defined benefit pension plan of the Robes Corporation for the year ended December 31, 2012:
Projected benefit obligation, January 1 Projected benefit obligation, December 31 Fair value of plan assets, January 1 Fair value of plan assets, December 31 Unrecognized past service cost, January 1 Unrecognized net actuarial loss, January 1 Contributions to the plan Benefits paid to retirees Amortization of past service cost P13,800,000 13,150,000 11,500,000 13,600,000 500,000 1,300,000 2,000,000 1,800,000 100,000

Actuarial change decreasing PBO Present value of available refunds and reductions in future contributions to the plan Expected return on plan assets Settlement rate Expected average remaining working lives of the employees participating in the plan QUESTIONS:

906,000 250,000 14% 12% 10 years

Based on the above and the result of your audit, determine the following: 1. Current service cost for 2012 a. P 400,000 b. P1,778,000 c. P506,000 d. P650,000

2. Actual return on plan assets in 2012 a. P 100,000 c. P1,900,000 b. P1,610,000 d. P2,100,000 3. Unrecognized net actuarial loss as of December 31, 2012 a. P104,000 c. P1,904,000 b. P 96,000 d. P1,010,000 4. Amount to be recognized in the statement of financial position as of December 31, 2012 a. P650,000 c. P954,000 b. P754,000 d. P504,000 5. Net amount to be recognized in 2012 profit or loss. a. P761,000 c. P996,000 b. P546,000 d. P746,000 Answers: 1) A; 2) C; 3) A; 4) B, 5) D Suggested Solution: Question No. 1 Projected benefit obligation, 1/1/2012 Current service cost (squeeze) Interest cost (P13,800,000 x 12%) Actuarial change decreasing PBO Benefits paid to retirees Projected benefit obligation, 12/31/2012 P13,800,000 400,000 1,656,000 ( 906,000) ( 1,800,000) P13,150,000

Question No. 2 Fair value of plan assets, 1/1/2012 Actual return on plan assets (squeeze) Contributions to the plan Benefits paid to retirees Fair value of plan assets, 12/31/2012 Question No. 3 Unrecognized net actuarial loss, 1/1/2012 P1,300,000 P11,500,000 1,900,000 2,000,000 ( 1,800,000) P13,600,000

Actuarial change decreasing PBO Difference between actual and expected return on plan assets [P1,900,000 (P11,500,000 x 14%)] Unrecognized net actuarial loss, 12/31/2012 Question No. 4 Debits Fair value of plan assets, 12/31/2012 Unrecognized past service cost, 12/31/2012 (P500,000 P100,000) Unrecognized net actuarial loss, 12/31/2012 Credit Present value of obligation, 12/31/2012 Prepaid (Accrued) pension expense, 1/1/2012

( 906,000) ( 290,000) P 104,000

P13,600,000 400,000 104,000 P14,104,000 P13,150,000 P 954,000

The amount recognized as a defined benefit liability shall be the net total of the following amounts: (PAS 19 par. 54) (a) the present value of the defined benefit obligation at the end of the reporting period; (b) plus any actuarial gains (less any actuarial losses) not recognized; (c) minus any past service cost not yet recognized; (d) minus the fair value at the end of the reporting period of plan assets (if any) out of which the obligations are to be settled directly. If the calculation of the statement of financial position amount as set out above results in an asset, the amount recognized should be limited to the net total of unrecognized actuarial losses and past service cost, plus the present value of available refunds and reductions in future contributions to the plan. (PAS 19 par. 58) The asset ceiling is computed below: Unrecognized net actuarial loss, 12/31/2012 Unrecognized past service cost, 12/31/2012 Present value of available refunds and reductions in future contributions to the plan Limit on the amount that may be recognized as asset P104,000 400,000 250,000 P754,000

Since the amount computed based on PAS 19 par. 58b is lower than the amount computed based on PAS 19 par. 54, the amount to be recognized in the statement of financial position should be limited to P754,000. The excess of P200,000 is recognized in accordance with the entitys accounting policy (i.e. either within or outside profit or loss). Question No. 5 Current service cost (see no. 1) Interest cost (P13,800,000 x 12%) Expected return on plan assets (P11,500,000 x 14%) Actuarial loss recognized (see below) Past service cost amortization Excess over limit on recognized asset (see no. 4) Net pension expense Unrecognized net actuarial loss, 1/1/2012 Less corridor (P13,800,000 x 10%) Excess P 400,000 1,656,000 (1,610,000) 100,000 200,000 P 746,000 P1,300,000 1,380,000 P 0