areaIII F. Lessee accounting

Question 1

Lessee accounting, particularly residual value guarantees, purchase options, and variable lease payments, is a

Answer 1

significant aspect of Financial Accounting and Reporting. Under ASC 842, “Leases,” these elements impact the recognition and measurement of lease liabilities and right-of-use (ROU) assets

Question 2

residual value guarantee is

Answer 2

an assurance made by the lessee to the lessor that the value of the leased asset will be at least a specified amount at the end of the lease
term.
● Accounting Treatment:
Include in the lease liability any amounts the lessee guarantees the lessor will realize at the end of the lease term.
The lease liability and ROU asset are initially measured based on the present value of lease payments, including any residual value guarantees

Question 3

purchase option allows

Answer 3

the lessee to purchase the leased asset at the end of the lease term.
● Accounting Treatment
If it’s reasonably certain that the lessee will exercise the purchase option, include the exercise price in the lease payments.
This results in a higher lease liability and ROU asset.

Question 4

Variable Lease Payments vary

Answer 4

based on changes in facts or circumstances occurring after the commencement date, other than the passage of time.
● Accounting Treatment:
Do not include variable lease payments (that depend on future activity or usage of the leased asset) in the lease liability or ROU asset.
Recognize variable lease payments in the period in which the obligation for those payments is incurred

Question 5

Under ASC 842, leases are classified as either

Answer 5

finance leases or operating leases

Question 6

A lease is classified as a finance lease if any one of the following criteria is met:

Answer 6

● Transfer of Ownership
● Purchase Option
● Lease Term: This means the lease term is 75% or more of the asset’s useful life.
● Present Value: This means 90% or more of the asset’s value.
● Specialized Nature: it is expected to have no alternative use to the lessor at the end of the lease term

If none of the above criteria are met, the lease is classified as an operating lease

Question 7

Annuity due vs. ordinary due

Answer 7

Annuity due means the payments are at the
beginning of each period, and an ordinary due means the payments are at the end of each period

Question 8

FAR1E10039

How are loan origination fees treated in income tax basis accounting?

A) Amortized over the life of the loan.
B) Expensed in the period received.
C) Recognized when the loan is repaid.
D) Deferred and recognized over the period they are deductible.

Answer 8

D) Deferred and recognized over the period they are deductible.

Loan origination fees are typically deferred and recognized over the period they are deductible for tax purposes.

Question 9

FAR3D10035

If a company recognizes a tax expense greater than the tax payable, what additional account should be debited?

A. Deferred Tax Asset
B. Deferred Tax Liability
C. Retained Earnings
D. Income Tax Receivable

Answer 9

A. Deferred Tax Asset

When the tax expense is greater than the tax payable, a Deferred Tax Asset is recognized, reflecting the future tax benefits due to temporary differences.

Question 10

FAR3D10014

How should changes in a valuation allowance for a deferred tax asset be reflected in the financial statements?
A. As an adjustment to retained earnings.
B. In the statement of comprehensive income.
C. In the income statement as part of tax expense or benefit.
D. Directly in the equity section.

Answer 10

C. In the income statement as part of tax expense or benefit.

Changes in a valuation allowance for a deferred tax asset should be reflected in the income statement as part of the tax expense or benefit. This reflects the impact of changes in the assessment of the company’s ability to realize the deferred tax asset in future periods.

Question 11

FAR1F10033
To calculate the Total Debt Ratio, which of the following formulas should be used?
A. Total Liabilities / Total Assets
B. Total Assets / Total Liabilities
C. Total Debt / Total Equity
D. Earnings Before Interest and Taxes (EBIT) / Interest Expense

Answer 11

A. Total Liabilities / Total Assets

The Total Debt Ratio is calculated by dividing Total Liabilities by Total Assets. It indicates the proportion of a company’s assets that are financed by debt. B is the inverse of this ratio, C is the Debt-to-Equity Ratio, and D is the Times Interest Earned ratio.

Question 12

FAR2I10009
What is the journal entry for the retirement of treasury stock?
A) Debit Treasury Stock, Credit Cash
B) Debit Treasury Stock, Debit Paid-in Capital from Treasury Stock, Credit Common Stock
C) Debit Treasury Stock, Debit Retained Earnings, Credit Common Stock
D) Debit Retained Earnings, Credit Treasury Stock

Answer 12

C) Debit Treasury Stock, Debit Retained Earnings, Credit Common Stock

When treasury stock is retired, Treasury Stock is debited for its cost, and if there’s a loss (i.e., the treasury stock’s cost was higher than the original issue price), Retained Earnings is debited for the difference, and Common Stock is credited for the original issue price.

Question 13

Spring Corp. entered into a five-year lease agreement with Fall Corp. Spring, the lessee, paid an additional $5,000 nonrefundable lease bonus to Fall upon signing the operating lease agreement. When would Fall recognize in income the nonrefundable lease bonus paid by Spring?
A. When received.
B. Over the life of the lease.
C. At the expiration of the lease.
D. At the inception of the lease.

Answer 13

B. Over the life of the lease.

The lease bonus would be recognized on a straight-line basis over the life of the lease.

Question 14

FAR2C10028
What is the effect of a purchase discount on the inventory account balance in a rollforward analysis?
A. It increases the inventory balance
B. It decreases the inventory balance
C. It has no effect on the inventory balance
D. It is treated as a separate line item

Answer 14

B. It decreases the inventory balance

A purchase discount decreases the cost of inventory purchased, thus reducing the inventory account balance in a rollforward analysis.

Question 15

FAR3F10027
If the initial direct costs of a lease are $5,000, how should these be accounted for in the right-of-use asset?
A. Expensed immediately as incurred.
B. Added to the right-of-use asset and amortized over the lease term.
C. Deducted from the right-of-use asset.
D. Recognized as a separate asset.

Answer 15

B. Added to the right-of-use asset and amortized over the lease term.

Initial direct costs are included in the right-of-use asset and amortized over the lease term. This treatment spreads the cost over the benefit period of the lease.

Question 16

Under ASC 842, the lessee’s lease cost recognition depends on

Answer 16

the type of lease: finance lease or operating lease

Question 17

In a finance lease, a lessee recognizes

Answer 17

interest expense on the lease liability and amortization expense on the right-of-use (ROU) asset

Question 18

Under an operating lease, a lessee recognizes

Answer 18

a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis

Question 19

Which of the following is the proper treatment of the cost of equipment used in research and development activities that will have alternative future uses?

A. Expensed in the year in which the research and development project started.
B. Capitalized and depreciated over the term of the research and development project.
C. Capitalized and depreciated over its estimated useful life.
D. Either capitalized or expensed, but not both, depending on the term of the research and development project.

Answer 19

C. Capitalized and depreciated over its estimated useful life.

Equipment that will have alternate future uses would be capitalized and depreciated just like regular business assets.

Question 20

FAR3D10033
What is the correct journal entry to record a deferred tax asset?
A. Debit Deferred Tax Asset; Credit Income Tax Expense
B. Debit Income Tax Expense; Credit Deferred Tax Asset
C. Debit Deferred Tax Asset; Credit Income Tax Payable
D. Debit Retained Earnings; Credit Deferred Tax Asset

Answer 20

A. Debit Deferred Tax Asset; Credit Income Tax Expense

To record a deferred tax asset, the journal entry is to debit the Deferred Tax Asset account and credit the Income Tax Expense account. This entry reflects the recognition of potential future tax benefits.

Question 21

FAR2E20004
In the context of amortized cost accounting, what is the primary focus when valuing an investment?
A) The current market value of the investment.
B) The historical cost of the investment.
C) The expected cash flows from the investment until maturity.
D) The potential for capital gains on the investment.

Answer 21

C) The expected cash flows from the investment until maturity.

Amortized cost accounting focuses on the expected cash flows from the investment until maturity. This method amortizes any discounts or premiums on the acquisition cost over the life of the investment, reflecting the earning process.

Question 22

FAR3F10016
How should a lessee classify a lease if the asset is of such specialized nature that only the lessee can use it without major modifications?
A. As an operating lease.
B. As a finance lease.
C. Based on the length of the lease term.
D. Based on the present value of lease payments.

Answer 22

B. As a finance lease.

A lease should be classified as a finance lease if the leased asset is of a specialized nature that only the lessee can use it without major modifications. This implies that the lessee gains most of the economic benefits from the asset.

Question 23

FAR1A20048
If the income statement reflects lower administrative expenses than the supporting documents, what could be the likely cause?
A) Misclassification of administrative expenses as cost of goods sold.
B) Overstatement of revenue.
C) Understatement of sales discounts.
D) Errors in recording asset disposals.

Answer 23

A) Misclassification of administrative expenses as cost of goods sold.

Misclassification of expenses is a common error causing such discrepancies. B), C), and D) are less likely to cause this specific discrepancy.