2) All long-term leases should be capitalized in the accounts by the lessee.

Transcription

1 Chapter 18 Leases 1) The principal attribute of finance leases is that the risks and rewards of asset ownership are deemed to remain with the lessor. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease 2) All long-term leases should be capitalized in the accounts by the lessee. LO: Account for operating leases from the perspective of lessees and lessors Topic: The Leasing Continuum 3) Operating leases are usually of shorter duration than finance leases and under this type of lease, the risks and rewards of asset ownership remain with the lessor. LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 4) The use of contingent lease payments is one method companies use to avoid lease capitalization. LO: List the criteria for classification of a finance lease and define related terms Topic: Contingent Rent 5) A lessee is usually motivated to report a lease liability as a finance lease because the lessee can capitalize the "cost" of the leased asset. LO: Summarize the advantages and disadvantages of using long term leases Topic: Avoiding Lease Capitalization 6) Under ASPE, the lessor is required to expense any direct costs associated with a lease up front. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 7) When the lessor is financial intermediary, a lease will usually qualify as a finance lease. LO: List the criteria for classification of a finance lease and define related terms Topic: An Informal Guideline Page 1

2 8) Companies that opt for finance leases usually do so because of the tax advantages finance leases provide. LO: Summarize the advantages and disadvantages of using long term leases Topic: Transfer of Income Tax Benefits 9) The lease expense amount recorded on a lessee's income statement will always be deductible for income tax purposes. LO: Summarize the advantages and disadvantages of using long term leases Topic: Transfer of Income Tax Benefits 10) The lessee's incremental borrowing rate is the rate that, at the inception of the lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset. LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Accounting for Finance Leases Lessee 11) The lessee should use the lessor's borrowing rate (if known) to account for a finance lease, even if this provides a present value of lease payments that is higher than the fair value of the asset at the inception of the lease. LO: List the criteria for classification of a finance lease and define related terms Topic: Discount Rate 12) Both guaranteed and unguaranteed residual values should be included in the calculation of the lessee's minimum lease payments of the lessee. LO: List the criteria for classification of a finance lease and define related terms Topic: Guaranteed versus Unguaranteed Residual Values 13) The same quantitative thresholds for determining the existence of finance leases apply under both IFRS and ASPE. LO: List the criteria for classification of a finance lease and define related terms, Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Finance Leases, Looking Forward Page 2

3 14) Geisler Company leased a building from Ryan Company for 5 years. The first year of the lease was forgiven with payments beginning in the second year. No journal entry is required until the second year. LO: Account for operating leases from the perspective of lessees and lessors, Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Definition of a Lease, Accounting for Finance Leases Lessee 15) The term of a finance lease includes the initial lease term and any bargain renewal terms. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease 16) To qualify as a lessor for tax purposes, a company must derive at least 90% of its revenues from leasing. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 17) If a lease transfers the residual value of the leased asset to the lessee at the end of the lease term, the lessee has permanent ownership of the leased asset. LO: List the criteria for classification of a finance lease and define related terms Topic: Guaranteed versus Unguaranteed Residual Values 18) If the straight-line method is used by the lessee to amortize the non-refundable down payment in an operating lease, a constant dollar amount of the prepayment is allocated as expense to each period covered by the lease. LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Amortization Table 19) The lessor's internal rate of return is normally the rate implicit in the lease. LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Implicit Interest Rate and Amortization Table Page 3

4 20) A lessee's insurance expense throughout the term of a finance lease is usually an estimate as opposed to an actual expense amount. LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 21) The effective interest method is normally used to compute the lessor's finance expense related to a finance lease. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 22) For an operating lease, the amount initially capitalized by the lessee is the present value of the lease rents to be paid over the lease term. LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 23) Any operating or executory costs should be excluded from the calculation of the minimum lease payments. LO: List the criteria for classification of a finance lease and define related terms Topic: Executory Costs 24) A finance lease is accounted for "as if" it transfers a material interest in the leased asset from the lessor to the lessee. LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 25) To be classified as a finance lease by the lessee, no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor may exist. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease Page 4

5 26) The definition of an operating lease is essentially a lease wherein the criteria for finance lease classification have not been met. LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 27) A finance lease is based upon the view that there was a sale/purchase (between the parties) of the leased asset at the inception date of the lease. LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 28) A lease which contains a bargain purchase option, but which has a term equal to only 70% of the estimated economic life of the leased property cannot properly be classified as a finance lease by a lessee. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease 29) Under both operating and finance leases, periodic rent expense for a lessee is likely to be the same over successive periods. LO: Account for operating leases from the perspective of lessees and lessors, List the criteria for classification of a finance lease and define related terms Topic: Finance Leases, Rent Expense, Contingent Rent 30) Contingent rent is a bargaining tool used by the lessee in order to negotiate a more favourable lease agreement. LO: List the criteria for classification of a finance lease and define related terms Topic: Contingent Rent 31) Contingent rent is one of three common methods used to avoid capitalization. LO: Summarize the advantages and disadvantages of using long term leases Topic: Use Contingent Rent Page 5

6 32) One of the most common methods of avoiding the capitalization of a lease is to enter into lease agreements that provide year-by-year renewal. LO: Summarize the advantages and disadvantages of using long term leases Topic: Avoiding Lease Capitalization 33) A sale and leaseback occurs when one party sells an asset to a second party who then leases it back to the first party. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Recording a Sale and Leaseback 34) A lessee's debt to equity ratio is not increased if the lease is a finance lease, whereas, it would be if the asset were purchased outright. LO: Summarize the advantages and disadvantages of using long term leases Topic: Long-Term Leases: Pros and Cons 35) Under ASPE, if a lessor's estimated future cash flow collections under finance leases are in doubt, an impairment loss may have occurred. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 36) Under ASPE, if a leased asset's fair value is less than its carrying value at the date of sale under a sale-and-lease-back transaction, the lessor has experienced an impairment loss. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 37) For a finance lease, the amount initially capitalized by the lessee is the sum of the future value of the periodic lease payments, plus the future value of any bargain purchase option. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease Page 6

7 Page 7 38) Both the lessee's interest and depreciation expense should be added back to net income to calculate cash flows from operating activities under the indirect method. LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Depreciation, Leases in the Statement of Cash Flows 39) Off-balance sheet financing occurs when a company makes use of assets but does not record the asset or corresponding liability on the financial statements. LO: Summarize the advantages and disadvantages of using long term leases Topic: Off-Balance-Sheet Financing 40) Leased assets treated as a finance lease for accounting purposes and an operating lease for tax purposes will create a temporary difference. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 41) Current IFRS standards do not distinguish between sales-type leases direct financing lease, as both are finance leases. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease 42) Sales-type leases are essentially a selling tool used by manufacturers to sell their merchandise. LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 43) The lessor recognizes two different kinds of earnings for a sales-type lease, that is, dealer's profit and interest revenue. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 44) Under a sales-type lease, the lessor recognizes a dealer's or manufacturer's profit on the date of inception of the lease. LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases

8 45) The same lease may be classified differently by the lessor as compared to the classification used by the lessee. LO: Account for operating leases from the perspective of lessees and lessors, List the criteria for classification of a finance lease and define related terms Topic: The Leasing Continuum, Classification as a Finance Lease 46) Non-refundable payments made in advance on operating leases may be amortized either over the term of the lease, or any other period consistent with the GAAP guidelines for amortizing intangible assets. LO: Account for operating leases from the perspective of lessees and lessors Topic: Definition of a Lease 47) In an operating lease, if a non-refundable down payment is made in advance, the lessor should initially debit Cash and credit Unearned Rent (liability). LO: Account for operating leases from the perspective of lessees and lessors Topic: Definition of a Lease 48) A journal entry is not required for either the lessor or lessee when an operating lease is initiated unless there is an advance payment, such as a lease bonus or prepayment of rent in addition to the periodic rents. LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 49) Each periodic rent collected on a finance lease by the lessor is usually part principal and part interest revenue. LO: List the criteria for classification of a finance lease and define related terms Topic: Contingent Rent 50) Finance revenue is recognized on a finance lease because the leased asset is considered sold at the inception of the lease, and the lease is a way of financing the lease. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward Page 8

9 51) All four finance lease criteria must be met in order for a lease to be deemed a finance lease. LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease 52) The recorded values of the asset(s) and corresponding liability at the inception of a finance lease (from the point of view of the lessee) will always be the same under ASPE and IFRS. LO: List the criteria for classification of a finance lease and define related terms, Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Finance Leases, Looking Forward 53) Sale and Leaseback arrangements may be finance or operating leases. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback 54) Under ASPE, when a sale leaseback qualifies as a capital lease, any gain or loss should always be amortized over the term over which depreciation is taken. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback 55) Under ASPE, any initial loss arising from a sale leaseback arrangement must be recognized immediately.. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback 56) Under ASPE, any initial gain or loss arising from a sale leaseback arrangement which is an operating lease must be recognized over the lease term. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback Page 9

10 57) The treatment of gains and losses under Sale and Leaseback arrangements are identical under ASPE and IFRS. LO: Describe and account for a sale leaseback transaction and other lease related issues, Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Recording a Sale and Leaseback, Looking Forward 58) Under IFRS, the proceeds of any lease arrangement involving both a parcel of land and building are prorated according to the fair values of the respective leasehold rights of the assets. LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Leases for Land plus Buildings 59) Under proposed changes to IFRS leasing standards, leases will generally be classified as short-term or long-term. The finance and operating lease classifications will disappear. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Short-Term and Low-Value Leases 60) Under proposed changes to IFRS leasing standards, a lease that is less than 12 months in duration may be classified as long-term if there are substantial penalties for non-renewal. LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Short-Term and Low-Value Leases Page 10

11 61) On January 1, 2014, WXY signed an operating lease agreement, which required $5,800 annual rentals to be paid at the end of each year. The accounting period ends December 31. At the end of 2014, WXY (lessee) should make the following entry: A) Please see the following table: Leased asset 5,800 Cash 5,800 B) Please see the following table: Rent paid in advance 5,800 Cash 5,800 C) Please see the following table: Rent expense 5,800 Lease liability 5,800 D) Please see the following table: Answer: D Rent expense 5,800 Cash 5,800 LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 62) While only certain leases are currently accounted for as a sale or purchase, there is theoretical justification for considering all leases to be sales or purchases. The principle reason that supports this idea is that: A) a lease reflects the purchase or sale of a quantifiable right to the use of the property. B) during the life of the lease, the lessee can effectively treat the property as if it were owned by the lessee. C) all leases are generally for the economic life of the property and the residual value of the property at the end of the lease is minimal. D) at the end of the lease, the property usually can be purchased by the lessee. Answer: A LO: List the criteria for classification of a finance lease and define related terms Topic: Classification as a Finance Lease Page 11

12 63) The term usually used to describe the situation where a lessee has an option to purchase the leased property at a price that is sufficiently lower than its fair market value so that the exercise of the option appears reasonably assured is: A) assured purchase option. B) bargain buy-out option. C) bargain purchase option. D) bargain renewal option. Answer: C LO: List the criteria for classification of a finance lease and define related terms Topic: Fair Value Ceiling 64) The appropriate valuation of an operating lease on the balance sheet of a lessee is: A) the present value of the sum of the lease payments discounted at an appropriate rate. B) the market value of the asset at the date of the inception of the lease. C) the absolute sum of the lease payments. D) zero unless the lessee made a prepayment of rent. Answer: D LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 65) The straight-line method is frequently used to amortize non-refundable rental payments made in advance on leased assets because: A) It is less complex, therefore, less costly. B) The interest method may result in unreliable amounts being recognized as expense. C) It is more theoretically sound. D) IFRS requires that it be used in all situations. Answer: A LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Depreciation Page 12

13 66) Assume the following facts relating to a lease: Leased asset, new at inception of lease term. Estimated useful life, 14 years. Lease term, 8 years; asset returns to lessor. Interest rate implicit in the lease, 10 percent (known by lessee). Lessee's marginal borrowing rate, 12 percent. Amount of each lease payment, $2,000. Lessor's cost of the leased asset, $15,164. Market value of leased asset at inception of the lease term, $15,164 Lease payments are due at the end of each period. From the perspective of the lessee, this lease should be classified as a(n): A) sales-type lease. B) direct financing lease. C) operating lease. D) finance lease. Answer: C LO: List the criteria for classification of a finance lease and define related terms Topic: Operating Leases 67) What is the cost basis of an asset acquired by a lease, which is in substance an instalment purchase? A) The present value of the market price of the asset discounted at an appropriate rate as an amount to be received at the end of the lease B) The present value of the future minimum lease payments under the lease (exclusive of executory costs and any profit thereon) discounted at an appropriate rate C) The net realizable value of the asset determined at the date of the lease agreement plus the sum of the future minimum lease payments under the lease D) The sum of the future minimum lease payments under the lease Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Accounting for Finance Leases Lessee 68) What are the three types of period costs that a lessee experiences with finance leases? A) Depreciation expense, executory costs, and lease expense. B) Executory costs, finance expense, and lease expense. C) Lease expense, finance expense, and depreciation expense. D) Finance expense, depreciation expense, and executory costs. Answer: D LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases Page 13

14 69) At the inception of a finance lease which calls for payments on an annuity due basis, the lessee typically debits: A) leased asset. B) lease expense. C) rent expense. D) lease receivable. Answer: A accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example 70) The lessee measures the cost of a leased asset, and the corresponding lease liability of a finance lease, as the: A) fair market value of the leased asset. B) future value of the periodic rental payments. C) sum of the annual cash payments to be made during term of the lease. D) present value of the periodic rental payments. Answer: D LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 71) The depreciation period used by the lessee for a depreciable leased asset must be: A) the same period that was used by the lessor. B) the remaining life of the asset from the lease inception. C) the term of the lease. D) at most the term of the lease but possibly longer if title is transferred at end of lease. Answer: D LO: Prepare the appropriate accounting entries and schedules for finance leases from the lessee's perspective Topic: Depreciation 72) For a finance lease, an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs such as insurance, maintenance, and property taxes to be paid by the lessor, together with any profit thereon, should be recorded by the lessee as a(n): A) expense. B) asset but not a liability. C) liability but not an asset. D) asset and a liability. Answer: D accounting entries and schedules for finance leases from the lessee's perspective Topic: Definitions, Finance Lease Illustration Basic Example Page 14

15 73) The estimated residual value of a depreciable leased asset at the end of the lease term is: A) added to the bargain purchase option at the expiration of the lease. B) always guaranteed by either the lessor or the lessee. C) an important factor in how the lessor and lessee must account for the lease. D) used by the lessor to compute the annual amount of depreciation expense. Answer: C LO: Account for operating leases from the perspective of lessees and lessors, List the criteria for classification of a finance lease and define related terms Topic: Rent Expense, Guaranteed versus Unguaranteed Residual Values 74) When the lessee guarantees the residual value at the end of the lease term, the: A) lessor will use this amount in computing periodic depreciation expense. B) lessor will receive an additional cash flow at the end of the lease term. C) lessee may have to pay the lessor additional cash if the actual residual value is not equal to the estimated residual value. D) lessee will have to pay the lessor additional cash because the guaranteed residual value was included in computing the annual rental amounts. Answer: C LO: List the criteria for classification of a finance lease and define related terms Topic: Guaranteed versus Unguaranteed Residual Values 75) If the residual value of a leased asset turns out to be more than the amount guaranteed by the lessee, the: A) lessee may reduce depreciation expense for the prior year, through a prior period adjustment, to take into account the excess. B) lessor is under no obligation to compensate the lessee for the excess. C) lessor must pay the lessee the amount of the excess. D) lessee may reduce the annual rentals for the excess. Answer: B LO: List the criteria for classification of a finance lease and define related terms Topic: Guaranteed versus Unguaranteed Residual Values 76) Which of the following would be excluded from both the minimum lease payments and net lease liability at inception for the lessee? A) Lessee guarantee of residual. B) Bargain purchase option. C) Third party guarantee of residual. D) Annual lease payments Answer: C LO: List the criteria for classification of a finance lease and define related terms Topic: Guaranteed versus Unguaranteed Residual Values Page 15

16 77) A lessee is attempting to circumvent the accounting rules, which require lease capitalization. Which of the following is most likely to lead to classification of a lease as an operating lease for the lessee? A) contract provides that lessee pays executory costs B) contract provides for a third-party guarantee of residual value C) attempt to reduce the lessee's borrowing rate D) increase the term of the lease. decrease annual executory costs Answer: B LO: Summarize the advantages and disadvantages of using long term leases Topic: Avoiding Lease Capitalization 78) On January 1, 2014, MU Corporation leased an asset, under an operating lease, to obtain the use of a special machine for three years. The lease payments were $9,000 per year payable at each year-end; the lessee must pay all operating expenses. At the inception date, MU Corporation should: A) record the asset at $27,000. B) record the rent expense of $27,000. C) record the asset at its fair market value. D) record the asset at the present value of the annual lease payments. E) make no entry. Answer: E LO: Account for operating leases from the perspective of lessees and lessors Topic: Operating Leases 79) A 5-year lease contract is signed on 1/1/x1 calling for $4,000 to be paid by the lessee on 12/31/x1, and $6,000 on 12/31/x2, x3, and x4. Total lease payments over the lease term are therefore $22,000. The lessee expects to use the leased asset evenly throughout the lease term, which ends 12/31/x4. No payment is due in 20x2. The entry recorded by the lessee for this operating lease, on 12/31/x1 includes which of the following? A) cr. rent payable $200 B) dr. rent expense $4,400 C) dr. prepaid rent $400 D) dr. rent expense $4,000 Answer: D LO: Account for operating leases from the perspective of lessees and lessors Topic: Rent Expense Page 16

17 80) ABC Inc. leased a jet from JKL Inc., a company that leases jet aircraft, on January 1 st, Year 1. Terms of the lease are as follows: 6 annual payments of $8,000,000 to be made every January 1 st, starting on January 1st, Year 1. ABC's incremental borrowing rate is 12%. ABC Inc. has not been made aware of JKL's borrowing rate. Both companies follow IFRS. The jet has a fair value of $38,000,000 at the start of the lease. JKL estimates that the jet will be worthless at the end of the lease term. There are no executory costs, however JKL, will incur $2 million in direct costs at the start of the lease. ABC Inc. depreciates all assets on a straight line basis. Both companies have determined that their respective leases qualify as finance leases. As a result of the information provided above, ABC would show total expenses of which of these following amounts for Year 2? A) $9,582,522 B) $9,055,557 C) $9,084,963 D) $10,046,510 Answer: A LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 81) The amount of finance revenue to be recognized by JKL Inc. during Year 2 would be: A) $2,104,672 B) $,2,537,864 C) $1,965,419 D) $1,637,124 Answer: A LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 82) Assume now that JKL Inc. adheres to ASPE. The interest rate used by the company to impute its interest revenue would now be: A) % B) 12% C) % D) % Answer: D LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases Page 17

18 83) Lessee ABC INC. leased from Lessor QRS a machine that cost $35,000, which was properly classified as a finance lease by both parties. Assume the lessor used a 12 percent implicit interest rate and that the lessee was informed of that rate. The lease did not include a bargain purchase option and the estimated residual value at termination of the lease was zero. Equal semi-annual lease payments are to be made at the start of each such period, including one on the date the lease was signed. The amount of each semi-annual payment, assuming a five-year lease term, would be: A) $2,074 B) $2,916 C) $4,486 D) $4,755 E) $9,709 Answer: C LO: List the criteria for classification of a finance lease and define related terms Topic: Finance Leases 84) The following information relates to a lease contract: Inception: 1/1/x1 Annual lease payments of $3,000 due each 12/31 beginning 12/31/x1 End of lease term: 1/1/x5 There are 4 lease payments in all Useful life of asset at inception: 10 yrs Expected residual value at 1/1/x5: $6,000 Lessee is given option to purchase asset at 1/1/x5 for $1,000 Using an interest rate of 10%, what is the present value of minimum lease payments for the lessee at inception? A) $10,193 B) $9,510 C) $10,419 D) $13,608 E) $13,000 Answer: A accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example Page 18

19 85) A lessor and lessee enter into a lease agreement with the following characteristics: Inception: 1/1/x0 6 annual lease payments of $10,000 are due each Jan. 1 beginning 1/1/x0 End of lease term: 12/31/x5 Book value of equipment under lease at inception: $35,000 Market value of equipment under lease at inception: $50,000 Remaining useful life of equipment at inception: 9 years Expected residual value at end of lease term: $4,000 Interest rate used by lessor and lessee: 10% Assuming the lessee will capitalize this lease, what is the amount of the net lease liability at inception, before the first payment is made? A) $47,908 B) $60,000 C) $50,166 D) $64,000 Answer: A accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example 86) An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due each January 1 beginning 1/1/x0. The unguaranteed residual value on 12/31/x4, the last day of the lease term, is estimated at $40,000. The lessor's implicit interest rate is 8%. What is the annual lease payment? A) $18,227 B) $16,877 C) $23,191 D) $25,046 Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example Page 19

20 87) An asset with a market value of $100,000 is leased on 1/1/x0. Five annual lease payments are due each January 1 beginning 1/1/x0. The lessee guarantees the $40,000 residual value as of 12/31/x4, the last day of the lease term. The lessor's implicit interest rate is 8%. What is the annual lease payment? A) $18,227 B) $16,877 C) $23,191 D) $25,046 Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example 88) A company became a lessee by leasing equipment on January 1, 2014 from a lessor. The lease has the following characteristics: Original useful life of asset 14 years Both lessor and lessee use 10% for lease capitalization Market value of equipment at lease inception $200,000 Book value of equipment at lease inception $150,000 Remaining useful life of equipment at inception 10 years A third party guarantees the entire residual value of $31,887 Six end-of-year lease payments are due beginning December 31, 2014 in the amount of $41,788 The lease term ends December 31, 2019 Assume this is a finance lease for both parties. What is the present value of minimum lease payments for the lessee? A) $200,000 B) $181,998 C) $180,000 D) $194,566 E) $178,233 Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Finance Lease Illustration Basic Example Page 20

21 Page 21 89) XYZ leased a tract of land for a 20-year term. The lease agreement did not contain a bargain purchase option, and consequently, the land will revert back to the lessor at the end of the lease term. At the inception of the lease, XYZ initiated construction on a small building on the land. The building was completed at the end of the third year of the lease, at a cost of $60,000. The building was a permanent structure on the land. Its estimated life was 20 years and was expected to have no residual value. XYZ should record annual depreciation (straight-line) on the building of: A) $2,400 B) $3,000 C) $3,529 D) $6,000 Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Depreciation 90) CDE leases land and secures the landowner's permission to erect a warehouse on the leased site. The lease has 25 years to run from the time CDE completes the warehouse at a cost of $300,000. The warehouse is expected to last 50 years. In connection with the warehouse, CDE's annual depreciation should be: A) $6,000 B) $7,500 C) $12,000 D) The entire $300,000 should be expensed the first year. Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Depreciation 91) Equal monthly rental payments for a particular lease should be charged to rental expense by the lessee for which of the following? Finance lease Operating lease 1 No No 2 No Yes 3 Yes No 4 Yes Yes A) Choice 1 B) Choice 2 C) Choice 3 D) Choice 4 Answer: B LO: Account for operating leases from the perspective of lessees and lessors, List the criteria for classification of a finance lease and define related terms Topic: The Leasing Continuum, Finance Leases

22 92) Lease Y contains a bargain purchase option and the lease term is equal to 75 percent of the estimated economic life of the leased property. Lease Z contains a bargain purchase option and the lease term is less than 75 percent of the estimated economic life of the leased property. How would the lessee classify these leases? Lease Y Lease Z 1 Finance lease Finance lease 2 Finance lease Operating lease 3 Operating lease Operating lease 4 Operating lease Finance lease A) Choice 1 B) Choice 2 C) Choice 3 D) Choice 4 Answer: A LO: Account for operating leases from the perspective of lessees and lessors, List the criteria for classification of a finance lease and define related terms Topic: The Leasing Continuum, Finance Leases 93) On December 31, 2015, JKL leased a new machine from MNO. The following information relates to the lease transaction: * the machine has an estimated useful life of seven years, which coincides with the lease term. * lease rentals consist of seven equal annual payments of $100,000, the first of which was paid on December 31, * MNO's implicit interest rate is 12 percent, which is known by JKL. * JKL's incremental borrowing rate is 14 percent at December 31, * present value of an annuity of $1 in advance for seven periods at 12 percent is * present value of an annuity of $1 in advance for seven periods at 14 percent is At the inception of the lease, JKL should record a capitalized lease liability of (choose the amount closest to your answer): A) $411,000 B) $489,000 C) $500,000 D) $511,000 Answer: D accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Accounting for Finance Leases Lessee Page 22

23 94) On December 31, 2015, JKL leased a new machine from MNO. The following information relates to the lease transaction: * Market value of the machine at inception of lease: $500,000 * the machine has an estimated useful life of seven years, which coincides with the lease term. * lease rentals consist of seven equal annual payments of $100,000, the first of which was paid on December 31, * MNO's implicit interest rate is 12 percent, which is known by JKL. * JKL's incremental borrowing rate is 14 percent at December 31, * present value of an annuity of $1 in advance for seven periods at 12 percent is * present value of an annuity of $1 in advance for seven periods at 14 percent is At the inception of the lease, JKL should record a capitalized lease liability of: A) $411,000 B) $489,000 C) $500,000 D) $511,000 Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Accounting for Finance Leases Lessee 95) ABC INC. leased a new machine from QRS on July 1, 2014, under a lease with the following pertinent information: Lease term 10 years Annual rental payable at the beginning of each lease year $30,000 Useful life of the machine 12 years Implicit interest rate 14 percent Present value of an annuity of $1 in advance for periods at 14 percent Present value of $1 for 10 periods at 14 percent 0.27 ABC INC. has the option to purchase the machine at the end of the lease term, by paying $40,000, which approximates the expected fair value of the machine on the option exercise date. The cost of the machine on QRS's accounting records is $150,000. On July 1, 2014, ABC INC. should record a net capitalized leased asset of: A) $150,000 B) $178,500 C) $189,300 D) $190,000 Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Accounting for Finance Leases Lessee Page 23

24 96) CDE leased equipment from HIJ on December 31, 2014, for a 10-year period (also the useful life of the asset). Equal annual payments under the lease are $50,000 and are due on December 31 of each year. The first payment was made on December 31, 2014, and the second payment was made on the next due date. The present value at December 31, 2014, of the minimum lease payments over the lease term discounted at 10 percent (the implicit rate computed by HIJ and known by CDE) was $338,000. CDE's incremental borrowing rate was 12 percent at December 31, The lease is appropriately accounted for as a finance lease by CDE. What should be the balance in CDE's liability under finance lease account at December 31, 2015? A) $266,800 B) $272,560 C) $303,980 D) $400,000 Answer: A accounting entries and schedules for finance leases from the lessee's perspective Topic: Finance Leases, Accounting for Finance Leases Lessee 97) On December 1, 2014, XYZ leased office space for its own use for 10 years at a monthly rental of $15,000. On December 31, 2014, XYZ paid the lessor the following amounts: Refundable rent deposit (for possible property damage) $20,000 First month's rent 15,000 Rent for last month of year 10 (paid in advance) 15,000 Installation of new walls and offices 96,000 Total $146,000 The entire amount of $146,000 was reported as rent expense in 2014 because it is an operating lease. What amount should XYZ have reported as expense for the year ended December 31, 2014? A) $15,000 B) $15,800 C) $30,800 D) $96,000 Answer: B LO: Account for operating leases from the perspective of lessees and lessors Topic: Rent Expense Page 24

25 98) Amanda Company leased an office building for six years for an annual rent of $170,000. The lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second year). The entry in the second year would include a debit to: A) deferred liability-$28,333 B) deferred liability-$141,667 C) rent expense-$170,000 D) rent expense-some other amount Answer: A LO: Account for operating leases from the perspective of lessees and lessors Topic: Uneven Payments 99) Amanda Company leased an office building for six years for an annual rent of $170,000. The lessor agreed to forgive the first year of the lease (i.e. payments would not begin until the second year). The entry in the second year would include a debit to: A) rent expense-$28,333. B) rent expense-$141,667. C) rent expense-$170,000. D) rent expense-some other amount. Answer: B LO: Account for operating leases from the perspective of lessees and lessors Topic: Rent Expense 100) JMR Company leases an asset from KAR Company. The rate implicit in the lease is 12% and JMR's incremental borrowing rate is 11%. JMR is aware of the implicit rate. Assuming that both rates would provide an MLP amount well below the fair value of the leased asset, the rate that JMR should use for discounting the net lease payment is: A) 11% under both ASPE and IFRS. B) 12% under ASPE and 11% under IFRS. C) 11% under ASPE and 12% under IFRS. D) 12% under both ASPE and IFRS. Answer: C LO: List the criteria for classification of a finance lease and define related terms, Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Discount Rate, Looking Forward Page 25

26 101) JMR Company leases an asset from KAR Company. The rate implicit in the lease is 12% and JMR's incremental borrowing rate is 11%. JMR is aware of the implicit rate. Assuming that both rates would provide an MLP amount well below the fair value of the leased asset, the rate that KAR should use for discounting the net lease payment is: A) 11% under both ASPE and IFRS. B) 12% under ASPE and 11% under IFRS. C) 11% under ASPE and 12% under IFRS. D) 12% under both ASPE and IFRS. Answer: C LO: Identify similarities and differences between the accounting for leases under IFRS and ASPE Topic: Looking Forward 102) Which of the following is not a possible advantage of long-term leases? A) 100% financing. B) Flexibility. C) Protection from interest rate changes. D) Ability to always claim CCA and depreciation. Answer: D LO: Summarize the advantages and disadvantages of using long term leases Topic: Long-Term Leases: Pros and Cons 103) All of the following are methods of avoiding capitalization except: A) legal agreement. B) use of contingent rent. C) use of a third party. D) shorten the lease term. Answer: A LO: Summarize the advantages and disadvantages of using long term leases Topic: Avoiding Lease Capitalization 104) In a sale and leaseback arrangement, the lessee is also: A) the new owner of the property. B) the seller. C) the buyer. D) a third party guarantor. Answer: B LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback Page 26

27 105) In a sale and leaseback situation: A) all gains and losses are deferred and amortized by the seller. B) if the present value of the lease payments is equal to or less than 90% of the fair value of the property, the lessee recognizes the entire gain or loss on sale immediately. C) the lessee immediately recognizes any loss on sale up to the amount of the difference between carrying value and fair value. D) the lessor recognizes all losses on the sale immediately but must defer and amortize all gains. Answer: C LO: Describe and account for a sale leaseback transaction and other lease related issues Topic: Sale and Leaseback 106) When a lessee measures the present value of future rentals to be capitalized under a finance lease, identifiable payments expected to be paid by the lessee to cover taxes, insurance, and maintenance should be: A) capitalized, but at a different discount rate and reported in a different account than the present value of the future rental payments. B) capitalized, but at a different discount rate and for a relevant period that usually is different than for the future rental payments. C) included in the present value of the future rentals to be capitalized. D) excluded from the present value of the future rentals to be capitalized. Answer: D accounting entries and schedules for finance leases from the lessee's perspective Topic: Contingent Rent, Accounting for Finance Leases Lessee 107) A bargain purchase option in a finance lease affects the: A) incremental target rate of return. B) dealer's profit in a sales-type lease. C) guaranteed residual value. D) lessee's capitalized cost of the leased asset. Answer: D accounting entries and schedules for finance leases from the lessee's perspective Topic: Classification as a Finance Lease, Accounting for Finance Leases Lessee Page 27

28 108) When the lessee guarantees the residual value at the end of the lease term, for accounting purposes, the: A) annual rentals will always be more than they would have been if the residual value was not guaranteed. B) guaranteed residual value does not affect the annual rentals because it is a cash flow at the end of the lease term. C) annual rentals will be the same as they would have been if the residual value was not guaranteed. D) annual rentals will always be less than they would have been if the residual value was not guaranteed. Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Guaranteed versus Unguaranteed Residual Values, Accounting for Finance Leases Lessee 109) When the lessee guarantees only a portion of the estimated residual value, the: A) lessee only takes into account the guaranteed portion when computing depreciation expense. B) guaranteed portion is disregarded when computing the annual rentals. C) lessor's and lessee's accounting entries will be symmetrical. D) lessee will never have to compensate the lessor for the excess of the guaranteed amount over the actual residual value. Answer: A accounting entries and schedules for finance leases from the lessee's perspective Topic: Guaranteed versus Unguaranteed Residual Values, Accounting for Finance Leases Lessee 110) Choose the correct statement regarding including the terms listed in the lessee's (1) minimum lease payments and (2) lease liability for a capitalized lease: (1) (2) 1 Unguaranteed residual No Yes 2 Lessee guarantee of residual Yes Yes 3 Third party guarantee of residual No Yes 4 Bargain purchase option Yes No A) Choice 1 B) Choice 2 C) Choice 3 D) Choice 4 Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Guaranteed versus Unguaranteed Residual Values, Accounting for Finance Leases Lessee Page 28

29 111) Which of the following is included in the lessor's cash flows but not the lessee's minimum lease payments? A) bargain purchase option B) unguaranteed residual value C) third party guarantee of residual D) lessee guarantee of residual value Answer: B accounting entries and schedules for finance leases from the lessee's perspective Topic: Guaranteed versus Unguaranteed Residual Values, Accounting for Finance Leases Lessee 112) A lessee wants to lease an asset on a long-term non-cancellable basis, but wants to avoid capitalizing the lease. The lessee is considering several strategies: 1) use a lessee guarantee of residual value; 2) make it impossible for the lessee, who has a very low borrowing rate, to determine the lessor's implicit rate, which is much higher than the lessee's borrowing rate; 3) include a bargain purchase option in the lease agreement; 4) include title transfer in the lease agreement. Which of the above strategies will provide the desired result? A) none B) 1 and 3 C) 1 and 4 D) 2 and 3 E) only 2 Answer: A LO: Summarize the advantages and disadvantages of using long term leases Topic: Avoiding Lease Capitalization 113) If a lessee does not exercise a bargain purchase option prior to its lapse date, the: A) lessee continues to record depreciation on the lease asset because it was assumed from the beginning that the lessee would retain ownership of the asset. B) bargain purchase option cannot lapse because this option was included in computing the annual rental amounts. C) lessee recognizes a loss due to the lapse. D) lessee recognizes a gain due to the lapse. Answer: C accounting entries and schedules for finance leases from the lessee's perspective Topic: Classification as a Finance Lease, Accounting for Finance Leases Lessee Page 29