ch21 Accounting for Leases

Question 1

Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of residual value to the lessor.

Answer 1

TRUE

Question 2

The IASB agrees with the capitalization approach and requires companies to capitalize all long-term leases.

Answer 2

FALSE

Question 3

A lease that contains a purchase option should be capitalized by the lessee.

Answer 3

FALSE

Question 4

Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.

Answer 4

TRUE

Question 5

A capitalized leased asset is always depreciated over the term of the lease by the lessee.

Answer 5

FALSE

Question 6

The use of an unrealistically low discount rate could leade to a lessee recording a leased asset at an amount exceeding the fair value of the equipment, which is generally prohibited in IFRS.

Answer 6

TRUE

Question 7

IFRS requires that lessees use the incremental rate to record a lease, unless it is impractical to determine it.

Answer 7

FALSE

Question 8

A lessee records interest expense in both a finance lease and an operating lease.

Answer 8

FALSE

Question 9

Lessors classify and account for all leases that do not qualify as direct-financing or sales-type leases as operating leases.

Answer 9

TRUE

Question 10

A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.

Answer 10

TRUE

Question 11

The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title.

Answer 11

FALSE

Question 12

Lessors classify and account for all leases that don’t qualify as sales-type leases as operating leases

Answer 12

FALSE

Question 13

Direct-financing leases are in substance the financing of an asset purchase by the lessee.

Answer 13

TRUE

Question 14

Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.

Answer 14

FALSE

Question 15

When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in a residual value, that stated amount is the guaranteed residual value.

Answer 15

TRUE

Question 16

Both a guaranteed and an unguaranteed residual value affect the lessee’s computation of amounts capitalized as a leased asset.

Answer 16

FALSE

Question 17

From a lessee’s viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments.

Answer 17

TRUE

Question 18

The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed.

Answer 18

FALSE

Question 19

In accounting for the initial direct costs for a sales-type lease, the lessor adds initial direct costs to the net investment in the lease and amortizes them over the life of the lease as a yield adjustment.

Answer 19

FALSE

Question 20

A common method of measuring the current liability portion in ordinary annuity leases is the change-in-the-present-value method.

Answer 20

TRUE

Question 21

The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.

Answer 21

FALSE

Question 22

The IASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.

Answer 22

TRUE

Question 23

Together the FASB and IASB hope to craft a new lease accounting standard that will eliminate the notion of the operating lease.

Answer 23

TRUE

Question 24

Which of the following is not an advantage of leasing?
a. off-balance-sheet financing
b. less costly financing
c. 100% financing at fixed rates
d. all of these answer choices are advantages

Answer 24

ALL OF THESE ANSWER CHOICES ARE ADVANTAGES

Question 25

Which of the following statements best describes current practice in accounting for leases?
a. leases are not capitalized
b. leases similar to installment purchases are capitalized
c. all long-term leases are capitalized
d. all leases are capitalized

Answer 25

Leases similar to installment purchases are capitalized.

Question 26

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?
a. No impact as the option does not enter into the transaction until the end of the lease term
b. The lessee must increase the present value of the minimum lease payments by the present value of the option price
c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price

Answer 26

THE LESSEE MUST INCREASE THE PV OF THE MINIMUM LEASE PAYMENTS BY THE PV OF THE OPTION PRICE

Question 27

The amount to be recorded as the cost of an asset under a finance lease is equal to the:

Answer 27

PV of the minimum lease payments or the fair value of the asset, whichever is lower

Question 28

The methods of accounting for a lease by a LESSEE are:
a. operating and finance lease methods
b. operating, sales, and finance lease methods
c. operating and leveraged lease methods
d. none of these answer choices are correct.

Answer 28

OPERATING AND FINANCE LEASE METHODS

Question 29

Which of the following is a correct statement of the capitalization criteria?
a. the lease transfers ownership of the property to the lessor
b. the lease contains a purchase option
c. the lease term is equal to or more than 75% of the estimated economic life of the leased property
d. the minimum lease payments (excluding executory costs) equal or exceed 90% of the fair value of the leased property

Answer 29

THE LEASE TERM IS EQUAL TO OR MORE THAN 75% OF THE ESTIMATED ECONOMIC LIFE OF THE LEASED PROPERTY

Question 30

Minimum lease payments may include:
a. penalty of failure to renew
b. bargain purchase option
c. guaranteed residual value
d. any of these answer choices

Answer 30

a. Penalty of failure to renew
b. Bargain purchase option
c. Guaranteed residual value

Question 31

Executory costs include:
a. maintenance
b. property taxes
c. insurance
d. all of these answer choices are correct

Answer 31

a. Maintenance
b. Property taxes
c. Insurance

Question 32

In computing the present value of the minimum lease payments, the lesser should use:
a. its incremental borrowing rate, in all cases
b. either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee
c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee.

Answer 32

USE EITHER ITS INCREMENTAL BORROWING RATE OR THE IMPLICIT RATE OF THE LESSSOR, WHICHEVER IS LOWER, ASSUMING THAT THE IMPLICIT RATE IS KNOWN TO THE LESSEE

Question 33

In computing depreciation of a leased asset, the lessee should subtract:
a. a guaranteed residual value and depreciate over the term of the lease
b. an unguaranteed residual value and depreciate over the term of the lease
c. a guaranteed residual value and depreciate over the life of the asset
d. an unguaranteed residual value and depreciate over the life of the asset

Answer 33

A GUARANTEED RESIDUAL VALUE AND DEPRECIATE OVER THE TERM OF THE LEASE

Question 34

Mika company leases telecommunication equipment. Assume the following data for equipment leased from Phlash Company. The lease term is 5 years and requires total rental payments of $3,150,000 at the beginning of each year. The present value of the payments was $13,135,059. The equipment has a fair value at the inception of the lease of $13,900,000, an estimated useful life of 8 years, and no residual value. Mika pays all executory costs directly to third parties. Phlash sets the annual retrun to earn a rate of return of 10%, and this fact is known to Mika. The lease does not transfer title or contain a bargain-purchase option. Based on this information, which of the following statement is true?
a. the lease should be classified as an operating lease
b. the lease meets the economic life test to be classified as a finance lease
c. the lease should be classified as a finance lease based on passing the recovery of investment test
d. the lease is classified as an operating lease for Mika and a finance lease for Phash

Answer 34

THE LEASE SHOULD BE CLASSIFIED AS A FINANCE LEASE BASED ON PASSING THE RECOVERY OF INVESTMENT TEST

Question 35

In the earlier years of the lease, from the lessee’s perspective, the use of the:
a. finance method will enable the lessee to report higher income, compared to operating method
b. finance method will cause debt to increase compared to the operating method
c. operating method will cause income to decrease, compared to the finance method

Answer 35

FINANCE METHOD WILL CAUSE DEBT TO INCREASE, COMPARED TO THE OPERATING METHOD

Question 36

A lessee with a finance lease containing a bargain purchase option should depreciate the leased asset over the:

Answer 36

ASSET’S REMAINING ECONOMIC LIFE

Question 37

Which of the following would not be included in the Lease Receivable account?
a. guaranteed residual value
b. unguaranteed residual value
c. a bargain purchase option.
d. all of the above would be included

Answer 37

ALL WILL BE INCLUDED IN THE LEASE RECEIVABLE ACCOUNT

Question 38

In a lease that is appropriately recorded as a direct-financing lease by the lessor, unearned income
a. should be amortized over the period of the lease using the effective interest method
b. should be amortized over the period of the lease using the straight-line method
c. does not arise
d. should be recognized at the lease’s expiration

Answer 38

SHOULD BE AMORTIZED OVER THE PERIOD OF THE LEASE USING THE EFFECTIVE INTEREST METHOD

Question 39

In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct financing lease is best defined as:

Answer 39

PRESENT VALUE OF MINIMUM LEASE PAYMENTS

Question 40

If the residual value of a leased asset is guaranteed by a third party:
a. it is treated by the lessee as no residual value.
b. the third party is also liable for any lease payments not paid by the lessee.
c. the net investment to be recovered by the lessor is reduced.
d. it is treated by the lessee as an additional payment and by the lessor as realized at the
end of the lease term.

Answer 40

IT IS TREATED BY THE LESSEE AS NO RESIDUAL VALUE

Question 41

When lessors account for residual values related to leased assets. they:
a. always include the residual value because they always assume the residual value will be realized.
b. include the unguaranteed residual value in sales revenue.
c. recognize more gross profit on a sales-type lease with a guaranteed residual value
than on a sales-type lease with an unguaranteed residual value.
d. All of these answer choices are true with regard to lessors and residual values.

Answer 41

ALWAYS INCLUDE THE RESIDUAL VALUE BECAUSE THEY ALWAYS ASSUME THE RESIDUAL VALUE WILL BE REALIZED

Question 42

The initial direct costs of leasing are:
a. are generally borne by the lessee.
b. include internal direct and indirect costs.
c. are expensed in the period of the sale under a sales-type lease.
d. All of these answer choices are true with regard to the initial direct costs of leasing.

Answer 42

EXPENSED IN THE PERIOD OF THE SALE UNDER A SALES-TYPE LEASE

Question 43

The primary difference between a direct-financing lease and a sales-type lease is the
a. manner in which rental receipts are recorded as rental income
b. amount of the depreciation recorded each year by the lessor
c. the recognition of the manufacturer’s or dealer’s profit at the inception of the lease

Answer 43

RECOGNITION OF THE MANUFACTURER’S OR DEALER’S PROFIT AT THE INCEPTION OF THE LEASE

Question 44

A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which amount:
a. The minimum lease payments plus the unguaranteed residual value.
b. The present value of the minimum lease payments.
c. The cost of the asset to the lessor, less the present value of any unguaranteed residual value.
d. The present value of the minimum lease payments less the present value of the unguaranteed residual value.

Answer 44

THE PV OF THE MINIMUM LEASE PAYMENTS LESS THE PV OF THE UNGUARANTEED RESIDUAL VALUE

Question 45

For a sales-type lease:
a. the sales price includes the PV of the unguaranteed residual value
b. the PV of the guaranteed residual value is deducted to determine the cost of goods sold
c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed

Answer 45

THE GROSS PROFIT WILL BE THE SAME WHETHER THE RESIDUAL VALUE IS GUARANTEED OR UNGUARANTEED

Question 46

Which of the following statements is correct?
a. In a direct-financing lease, initial direct costs are added to the net investment in the lease
b. In a sales-type lease, initial direct costs are expensed in the year of incurrence
c. For operating lease, initial direct costs are deferred and allocated over the lease term

Answer 46

a. In a direct-financing lease, initial direct costs are added to the net investment in the lease
b. In a sales-type lease, initial direct costs are expensed in the year of incurrence
c. For operating lease, initial direct costs are deferred and allocated over the lease term

Question 47

All of the following statements are true with regard to how the statement of financial position will be similarly affected by leasing the assets as opposed to issuing bonds and purchasing the assets, except with statement?
a. Since a long-term, non-cancelable lease which is used as a financing device generally results in the capitalization of the leased assets and recognition of the lease commitment in the statement of financial position, the comparative effect is not very different from purhcase and ownership
b. Assets leased under finance leases would be capitalized at the present value of the future lease payment, which is somewhat equivalent to the purchase price of the assets
c. Bonds sold at par would be nearly equivalent to the PV of the future lease payments
d.The specific accounts affected by the transactions would be the same

Answer 47

THE SPECIFIC ACCOUNTS AFFECTED BY THE TRANSACTIONS WOULD BE THE SAME

Question 48

All of the following are ways in which companies avoid leased assets capitalization in devising lease agreements, except:
a. ensure that the lease does not specify the transfer of title of the property to the lessee
b. do not write in bargain-purchase option
c. arrange for the present value of the minimum lease payments to be sufficiently more than the fair value of the leased property
d. set the lease term sufficiently below the estimated economic life of the leased property such that the economic life test is not met.

Answer 48

Arange for the present value of the minimum lease payments to be sufficiently more than the fair value of the leased property

Question 49

If companies want to disqualify a lease as finance lease to the lessee, while having the same lease qualify as a finance (sales or financing) lease to the lessor, which of the following are true?
a. It cannot be done
b. They must make info about the implicit rate unavailable to the lessee and use of the incremental borrowing rate by the lessee when it is higher than the implicit interest rate of the lessor.
c. They must include a bargain purchase option
d. They must specify the transfer of the property to the lessee

Answer 49

They must make info about the implicit rate unavailable to the lessee and use of the incremental borrowing rate by the lessee when it is higher than the implicit interest rate of the lessor.

Question 50

All of the following statements are true regarding the circumvention of accounting rules for leases when determining whether a lease qualifies as an operating or capital lease except:
a. the residual value guaranteed is a device used by lessees and lessors by transferring some of the risk to a third party to convert financing leases to operating leases
b. the lessee who does not know exactly the lessor’s implicit interest rate might use a different(higher) incremental borrowing rate
c. lessors typically try to avoid having lease arrangement classified as operating leases
d. lessors typically try to avoid lease arrangement classified as finance leases.

Answer 50

Lessors typically try to avoid lease arrangement classified as finance leases.

Question 51

Which of the following is true regarding footnote disclosure of operating lease payments under IFRS and US GAAP?
a. US GAAP does not require as much detail as IFRS
b. it is more difficult to estimate the impact of the off-balance sheet liabilities for companies that use US GAAP compared with IFRS companies
c. extensive disclosure of future noncancelable lease payment is required for the next five years and the years therafter under IFRS
d. IFRS typically has no detail on the year-by-year breakout of lease payment due

Answer 51

Extensive disclosure of future noncancelable lease payment is required for the next five years and the years therafter under IFRS

Question 52

The Lease Liability account should be disclosed as:
a. all current liabilities
b. non-current liabilities
c. current portions in current liabilities and the remainder in non-current liabilities
d. deferred credits

Answer 52

Current portions in current liabilities and the remainder in non-current liabilities

Question 53

To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal?
a. Lessee uses a higher interest rate than that used by lessor
b. Set the lease term at something less than 75% of the estimated useful life of the property
c. Write in a bargain purchase option
d. Use a third party to guarantee the asset’s residual value

Answer 53

WRITE IN A BARGAIN PURCHASE OPTION

Question 54

If the lease in a sale-leaseback transaction meets one of the four leasing criteria and is therefore accounted for as a finance lease, who records the asset on its books and which party records interest expense during the lease period

Answer 54

Party recording the asset on its books
SELLER-LESSEE

Party recording interest expense
SELLER-LESSEE

Question 55

In a sale-leaseback transaction where none of the four leasing criteria are satisfied, which of the following is false?
a. the seller-lessee removes the assets from its books
b. the purchaser-lessor records a gain
c. the seller-lessee records the lease as an operating lease
d. all of these answers are false statements

Answer 55

THE PURCHASER-LESSOR RECORDS A GAIN

Question 56

When a company sells property and then leases it back, any gain on the sale should usually be:

Answer 56

DEFERRED AND RECOGNIZED AS INCOME OVER THE TERM OF THE LEASE

Question 57

Which of the following is true regarding the deferral of sale profits on a sale-leaseback using IFRS?
a. Both profits and losses on a sale followed by an operating lease leaseback are recognized immediately if the transaction is established at fair value
b. Profit from the sale should be amortized in proportion to the rental payments if an operating lease results from the sale-leaseback
c. Any profit on a sale-leaseback resulting in an operating lease is deferred and recognized over the subsequent lease period, whereas any loss is recognized immediately
d. Profit from the sale should be deferred and amortized in proportion to the amortization of the leased asset if a capital lease results from the sale-leaseback

Answer 57

Both profits and losses on a sale followed by an operating lease leaseback are recognized immediately if the transaction is established at fair value