Reference no: EM133045460

Question - BTS Company entered into a 10-year lease of a commercial space on January 1, 2021. Annual lease payment payable at the beginning of each year amounted to P500,000. The company has paid commissions of P200,000to Army TM, a real estate brokerage firm that have helped the company closed the reasonable deal with the lessor.

Details found on the signed contract of lease are as follows:

Residual value at the end of the lease term (20% is not guaranteed)- P250,000

Purchase option at the end of the lease term- P150,000

Annual property taxes (amount to be shouldered by the lessee)- P50,000

Lessee's share in annual insurance- P30,000

Annual budgeted repairs and maintenance expenses- P20,000

The cost of dismantling the improvements and fixtures and restoring the commercial space into its original intended use after the end of the lease term is estimated to be at P350,000.

Considering the flooding, fault line and deterioration in the vicinity and the current plan to build a cemetery in front of the leased premises, the appraiser estimated that the fair value of the leased commercial space at the end of the lease term is just P125,000. He also estimated the remaining economic life of the property to be 12 years.

BTS incremental borrowing rate is 8%, which is also the prevailing interest rate in 2020. Based on the unrevealed intelligence gathered by Army TM, the implicit interest rate is 6%.

Required - Compute the lease liability and the right of use asset after first payment as of January 1, 2021 and after determining the most likely decision of the company as to whether it will purchase or return the commercial space at the end of the lease term.