Reference no: EM133188298
Question - Lessee enters into a 10-year lease of a floor of a building, with an option to extend for five years. Lease payments are P55,000 per year during the initial term and P50,000 per year during the optional period, all payable at the beginning of each year. To obtain the lease, Lessee incurs initial direct costs of P20,000, of which P15,000 relates to a payment to a former tenant occupying that floor of the building and P5,000 relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the lease, Lessor agrees to reimburse to Lessee the real estate commission of P5,000 and Lessee's leasehold improvements of P7,000.
At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore, determines that the lease term is 10 years.
The interest rate implicit in the lease is not readily determinable. Lessee's incremental borrowing rate is 5 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and with similar collateral. Discount factor for 5% for 9 periods is 7.10782.
At the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease. Lessee's incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee remeasures the lease liability at the present value of four payments of P55,000 followed by five payments of P50,000, all discounted at the revised discount rate of 6 per cent per annum, which is P378,855.00.
Lessee expects to consume the right-of-use asset's future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset on a straight-line basis.
1. Determine the amount of depreciation expense recognized in Year 3 in relation to the right-of-use asset.
2. Determine the amount of interest expense recorded during Year 3.
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