Chapter 12: Leases and Contingencies

Question 1

When are contingencies recognized?

Answer 1

They are recognized when realized, however, they can be disclosed depending on probability. Gain contingencies are NOT recorded.

Question 2

What is the interest revenue recognized over the lifetime of a lease?

Answer 2

The difference between the GROSS lease payments received and their PV

Question 3

What are the five criteria that a lease must meet at least 1 to be considered a finance lease by the lessee? And a sales-type lease by the lessor?

Answer 3

1. Lease transfers ownership of the leased asset to the lessee
2. Lease contains a purchase option the lessee is reasonably certain to exercise
3. The lease term takes up 75% or more of the leased asset’s economic life
4. The PV of the sum of the lease payments is 90% or more of the leased asset’s fair value
5. The leased asset is so specialized that it is expected to have no alternative use to the lessor at the end of the lease term

Question 4

When is a contingent loss accrued?

Answer 4

It is probable that at the BS date an asset is overstated or liability has been incurred, and the amount of the loss can be reasonably estimated. If the probability of the loss is at least reasonably possible, the amount must be disclosed.

Question 5

If none of the 5 criteria are met for a lease to be considered a finance lease by the lessee what is the lease classified as?

Answer 5

Operating lease

Question 6

If none of the criteria are met for a lease to be considered a sales-type lease by the lessor what is the lease classified as?

Answer 6

Operating lease or a direct financing lease.

Question 7

What are the criteria needed to be met for a lessor to classify a lease as a direct finance lease?

Answer 7

1. The lease is not a sale type lease
2. The PV of the sum of lease payments and residual value guaranteed by third party = > the fair value of the leased asset
3. It is probable that the lease payments and residual value will be collected

Question 8

What are the short-term lease criteria?

Answer 8

1. Lease term of less than 12 months
2. The lessee is not reasonably expected to exercise a purchase option

Question 9

What is a lease liability amount equal to?

Answer 9

The PV of lease payments using the discount rate or either the lessor’s implicit rate if known to lessee or the lessee’s incremental borrowing rate

Question 10

What are the components of the lease liability under an operating lease for the lessee?

Answer 10

Lease payment - Interest Expense

Question 11

What is the initial journal entry for the lessor for a sales-type lease?

Answer 11

(DB) Net investment in lease
(DB) Cost of goods sold
(CR) Revenue
(CR) Leased Asset

Question 12

When is a gain contingencies recognized?

Answer 12

When they are realized.

Question 13

Under both finance and operating leases, at the lease commencement date a lessee must

Answer 13

Must recognize a lease liability and a right-of-use asset.

Question 14

If none of the five criteria are met to be considered a finance lease by the lessee, what is the lease classified as?

Answer 14

An operating lease.

Question 15

When does a lessor classify a lease as a direct financing lease?

Answer 15

If the lease includes a residual value guarantee by a third party that is not the lessee that results in meeting the “substantially all of the fair value” classification criterion. These are RARE.

Question 16

What are MOST leases classified as by a lessor?

Answer 16

Sales-type lease or an operating lease.

Question 17

As an accounting policy what can a lessee choose under a short term lease?

Answer 17

A lessee may elect not to recognize the right-of-use asset and lease liability.
(DB) Rent expense
(CR) Cash or rent payable

Question 18

For finance and operating leases what must a lessee must recognize?

Answer 18

A lease liability and a right-of-use asset.

Question 19

How does the accounting for a finance lease differ from an operating lease?

Answer 19

The account is the same except for the subsequent measurement of the right of use asset

Question 20

What are the two components for each periodic payment made by the lessee?

Answer 20

Interest expense and the reduction of the lease liability.

Question 21

If the first periodic lease payment is made at the commencement date of the lease, what component is recognized?

Answer 21

A reduction of the lease liability immediately for the full period lease payment. No interest expense is recognized for the first payment bc no time has elapsed between the lease commencement date and the payment.

Question 22

What is the interest expense for a lease liability for a lessee?

Answer 22

Lease liability at the beginning of the period x Discount rate

Question 23

What is the reduction of the lease liability for the lessee under a finance lease?

Answer 23

Periodic lease payment - Interest expense

Question 24

How is a lease expense recognized under an operating lease for a lessee?

Answer 24

A single (equal) lease expense is recognized in each period (spilt between the amortization expense on right-of-use asset and interest expense on lease liability)

Question 25

How is an operating lease reported on a income statement?

Answer 25

In a single amount for the total lease expense for the period is reported in income from continuing operations (interest expense for the lease liability and amortization expense for the right-of-use asset are not reported separately)

Question 26

What is the amortization of the right-of-asset for a lessee under an operating lease?

Answer 26

The difference between the (1) single periodic lease expense and (2) interest expense on the lease liability recognized for the period

Question 27

What is the interest expense equal to for the lessee under an operating lease?

Answer 27

The carrying amount of the lease liability at the beginning of the period times the discount rate of the lease.

Question 28

What does the lease liability equal to which sometimes will differ from the ROU asset?

Answer 28

The lease payment - interest expense
The ROU asset will be the total lease payments divided by the lease term.

Question 29

The fair value of the leased asset differs from its carrying amount. What are the components of the lease receivable for a lessor involved in a sales-type lease?

Answer 29

The lease receivable recognized by the lessor at the commencement of the lease is measured at the present value of the lease payments plus the present value of residual value guaranteed by the lessee or any other third party.