FAR - F5: Leases, Liabilities, and Bonds

Question 1

F5: Present Values and Annuities

Ordinary Annuity vs. Annuity Due

Answer 1

Ordinary Annuity - Start later - at the end of the period.

**Payment due at the end of the year/period

Annuity Due - Start Now - at the beginning of the period.

**Payment due at the beginning of the year/period.

Question 2

**Annuity Factor

Answer 2

Annuity Due factor: You will find Annuity Due factor if you add 1 on the ordinary Annuity factor
** Ordinary Annuity + 1 = Annuity Due factor

• *Ordinary Annuity factor, if you subtract 1 from Annuity due.
• *Annuity Due - 1 = Ordinary Annuity factor

Question 3

• Present Value of $1
• U.S. Saving bond

**Future Value of $1

• Bank Saving Account

Answer 3

• Capital lease buyout (at end of lease)

- Bond Principal payoff at the end of term

Question 4

• *Present Value of an Ordinary Annuity (payment start later)
• Winning the Lottery

**Future Value of an Ordinary annuity

-Investing in an IRA

Answer 4

• Periodic lease payments

- Periodic bond payments

Question 5

*Present Value and Future value of Annuity Due

Answer 5

**Present value of an ordinary annuity for 3 periods at 8% = 2.577
Plus: 1
Present value of an annuity due for 4 periods at 8% =3.577

Question 6

F5: Accounting for Lease

2 types of Leases:

1. Operating Lease
2. Capital Lease

or Financing Lease (Internationally)

Answer 6

**Operation Lease - Rental Agreement

• *Capital Lease - Sale ( in substance over form)
• option to buy at the end of lease
• or capitalize while you are using it.

JE:
Dr - Asset
Cr - Liability

Question 7

Operating Leases - Rental Agreement

**Lessee Accounting

Answer 7

**Accounting for Operating Leases

a. Lease Rent Expense - Renter

b. Lease Bonus - Commission Paid to real estate agent
- Deferred change and amortized using SL method over the life of the lease

c. Leasehold Improvements
- Capitalize Leasehold Improvements
- Depreciation - Useful life or lease term
- “Lesser of:”
a. Lease life
b. Asset/Improvement life

d. Rent Kicker - Period expense
e. Refundable Security Deposit

f. Free or Reduced Rent Consideration
- For example, Free rental for 6 months:

5 years (60 months) @ $1,000  $60,000
First 6 months are free 
Net Cost for 5 years:  $54,000
Total months Rented /60 months
----------------------------------------
Monnthly Rental Expense: $900

Journal Entry:
First 6 month (months 1 - 6)
Dr - Rent Expense $900
Cr- Rent Payable - $900

Next 54 months (months 7 -60)
Dr - Rent Expense $900
Dr - Rent Payable $100
Cr - Cash/Rent payable

**same expense every period (Straight-Line S/L)

Question 8

**Lessor Accounting - Owner

Answer 8

a. Fixed Asset
- Depreciation - over the asset’s useful life.

b. Rental Income
-JE:
Dr - Cash/Rent Receivavle
Cr - Rental Income

c. Security deposits
- Nonrefundable - deferred by the lessor (unearned revenue) and capitalized by the lessee (prepaid rent expense) until the lessor considers the deposit earned.

-Refundable - Treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded to the lessee.

Dr - Cash
Cr - Refundable deposit.

**Revenue is only recognized when the earning process is complete.

***You estimate expenses and losses based on the historical cost. But revenue you wait until the earning process is complete.

**“DO NOT ANTICIPATE FOR REVENUE” - DO NOT GET TRAP FOR THESE KIND OF QUESTIONS.

d. Temporary Difference

• GAAP - prepaid rental income when earnd.
• Tax rule - prepaid rental income when received

e. Lease Bonus
f. Free or Reduce Rent Consideration.

**In terms of Lessor perspective:

First 6 months (months 1 - 6)
Dr - Rent Receivable
Cr - Rent Income

Next 54 months (months 7 - 60)
Dr - Cash
Cr - Rent Income
Cr - Rent Receivable.

**Same income every period (S/L)

Question 9

**Example - Operating lease with Lease Bonus

Answer 9

Monthly rental ($32,000 x 12) $384,000
Plus: Lease Bonus Amortization ($75,000x1/3) 25,000
Less: Depreciation($1,500,000/10y) (150,000)
——————————————
Income from leased asset, Year 1: $259,000

Monthly rentals expense $384,000
Plus: Lease bonus amortization $25,000
—————————————–
Expense for leased asset, Year 1: $409,000

Question 10

**Capital(US)/Finance(IFRS) Lease = Purchase/Ownership

• *According to Roger CPA Review
• Must meet one condition to capitalize. (Only 1 require)
• TT (Title transfer)
• BPO (Bargain purchase Option)
• 75 % of Life (75% of the economic life)
• 90 % for Fair Value (90% of the FV =

Answer 10

A. Lessee (Buyer) Capital Lease Criteria (U.S. GAAP)

• OWNS test
• Must meet just one condition to capitalize.

O - Ownership transfer a the end of lease

W - Written option from Bargain Purchase

N - Ninety (90%) percent of leased property Fair value (FV) =

Question 11

**B. Lessee Finance Lease Criteria (IFRS)

Answer 11

What are the lease criteria IFRS has and how they are different from U.S. GAAP?

IRFS - OWNS FACS

1. Lease Transfer Ownership - O
2. Written Bargain - W
3. Economic life - E
4. PV is substantially all the Fair Value - S
   - —————————— U.S. GAAP
5. Gains and Losses from the fluctuation in the fair value of the residual accrue to the lessee. F
6. The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent. - A
7. The lessee can cancel the lease and the lessor’s losses associated with the cancellation are borne by the lessee - C
8. The lease assets are of such a specialized nature that only the lessee can use them without modification -S

Question 12

**Lessor - Sales-type/Direct Financing typre criteria (U.S. GAAP)

Answer 12

**For Seller:

• Seller must have meet all 3 criteria in order to claim that they sold the asset.
  1. Lessee “owns” the leased property (Meets any one of the four lessee’s criterial) - L
  2. Uncertainties do not exist any unreimbursable costs to be incurred by the lessor
  3. Collectability of the lease payments is reasonably predictable.

Question 13

**Sales-Type Lease

and

**Direct Financing Lease

Answer 13

• *Sales-Type Lease
• 2 profits
  1. Gain on Sale
  2. Interest income
• *Direct Financing Lease
• 1 Profit
• Interest Income

Question 14

**Lessee Capital (Finance) Lease Accounting:

Answer 14

• *For Buyer
• *If the party owns it

Dr - Assets
Cr - Liability

**Recording the Lease:

a. Capitalized Amount
* *Lessee records the lease as an asset and a liability a the lower of:

1. Fair Value of the Asset
2. Cost = Present Value of the minimum lease payments.

• *Include:
  i. Required Payments
  ii. Bargain Purchase Options
  iii. Guaranteed Residual value.
• *Exclude:
  i. Executory costs - insurance, maintenance, taxes

ii. Optional Buyout - not required and not a bargain.

Question 15

**Calculating the present value of the minimum lease payments…

Answer 15

**Periodic payment —> 1. Beginning of period = PV of an Annuity Due

——> 2. End of Period = PV of an Annuity (in arrears/ordianry)

Bargain Purchase Option

or

Guaranteed residual —> PV of $1.

Question 16

b. Interest Rate…

Answer 16

• *Uses Lower/lesser of these 2:
  1. Rate implicit in the lease (if known)

2. Lessee’s incremental borrowing rate (The rate available in the market to the lessee (not prime)

Question 17

**Remember the capitalization amount computation rules is to recall that leases are between a lessee and lessor…

Answer 17

**Therefore, always use the lesser of:

1. Cost or market
2. Implicit interest rate or incremental borrowing rate.

Question 18

**Fact Patterns - Recording a capital lease - Lessee’s Book

• ten years
• Annual rental of $5,000
• 10%
• beginning of the first year
• asset’s economic life is 12 year
• lease payment 34,000

Answer 18

Step 1 - Does the lease meet the criteria for capitalization?

Ownership transfer –> No
Written Bargain –> No
90% FV - Yes (34,000 x 90% = $30,600

Question 19

**Depreciation Mehod

Answer 19

Capitalized lease assets

---------------------------------
Depreciable Basis
/ Periods of benefit
-------------------------------
Depreciation Expense (Per period)
=============================

Question 20

• *Lessor Accounting
• Seller (with all the “LUC”)

Pass Key:

Rule for Sales -type lease:

Cost
+Profit
—————
Present Value = Selling price = FV (Fair value)

or

Selling price = Cost + Profit ***(When the sales price is not given then this is the assumption you make)

Answer 20

A. Recording a Sales-Type (Finance) Lease

1. Gross Investment
   - ——————————–
   - 2 profits
2. Gain on Sale
3. Interest income.

Formula:

Lease payment - Gross
\+Unguaranteed value - Est. FV at end
-------------------------------------
Gross Investment
========================

2. ## Net InvestmentLease Payment - Principal
   +Unguaranteed residual value
   ——————————————-
   Gorss Investment
   x PV
   ==================
   Net Investment/Net Principal
3. ## Unearned Interest Revenue (Contra lease receivable)Gross investment

Unearned interest revenue/Future interest
—————————————-

4. ## Cost of Goods SoldCost of Assets

Cost of Goods Sold
=========================

or
Sold

Net given up
=====================

5. Sales Revenue
   - —————————-

**Present Value of the minimum “lease payment” is recorded as “Sales Revenue.”

Question 21

**B. Recording a Direct Financing (Finance) Lease

**Seller (will all the “LUC”)

1 Profit:
-Interest income

Note:

• NO Sales
• NO Cost of Goods Sold

Answer 21

1. Gross Investment

Lease payments - Gross
\+Unguaranteed residual value
---------------------------------------
Gross investment
=========================

2. Net Investment

Gross investment - Principal
x PV
————————————
Net Investment

3. Unearned Interest Revenue

Gross investment

Unearned Interest revenue

• *We are bank - financing
• *NO Cost of Goods.

Question 22

**Sales-lease back.

Answer 22

**General Rule:

• Over 90% = Loan
• 10% -90% = Rules
• 0 - 10% = ignores

Question 23

3. Excess Profit on Sale-leaseback (US GAAP Only)

Answer 23

Formula:
Sales Price

Tentative Gain

Excess Gain
====================

Gain on Sale

Keep
====

Formula:
Sales Price

Tentative Gain

Excess Gain
====================

Gain on Sale

Keep
=========

Question 24

C. Accounting by Seller/Lessee (US GAAP)

a. leaseback over 90% of sales price
Major lease-back
———————–
Defer all gain

b. 10% to 90%
middle lease-back
—————————
Defer gain up to give back

c. 0% to 10%
minor lease-back
————————–
Recognize gain (ignore deferral rules)

**Compare with Sale price/fair value with Present Value of lease rentals to determine Major, Middle and Minor.

Answer 24

1. Amount of Deferred Gain
   a. “Substantially All” Rights Retained ( lease back is greater than 90% of sales price)
   b. Rights Retained are less then “Substantially All” but Greater than “Monor” - Between 90% - 10%

c. Minor Portion of Rights Retained by Seller-lessee (less than 10%)
- Gain is not deferred

d. Real Economic LOSS Recognize immediately.
- Real Economic Loss - A loss that must be recognized immediately
- Artificial loss - When the sales price is below the fair value, the loss is deferred and amortized over the leaseback period.

Question 25

**Example - Lease back - “Minor” rights Retained (U.S. GAAP)

**PV of the minimum lease payment is less then 10% of the Fair Value of the sale price, therefore, it is minor and recognize all gain.

Answer 25

**Sales Price, Fair Value: $360,000
Carrying amount (BV): $315,000
——————————-
Gain $45,000

Estimated remaining useful life: 12 years
Monthly rent payment $3,000
Present value of lease rentals: $34,000

How much profit should LInda recognize on the sale? No deferral.

Step 1 - First determine the character of the lease - Operating lease

Step 2 - Determine the portion of rights retained by the seller-lessee.

The present value of annuity $34,100 is less then $36,000 (10% x 360,000), Linda retained a “Minor” portion of rights in the asset.

Therefore, Lind would recognize the entire $45,000 gain ($360,000 - $315,000) immediately.

Question 26

**Accounting by Seller/Lessee (IFRS)

Answer 26

1. Finance Lease
   - If a sale-leaseback transaction results in a finance lease, any profit from the sale-leaseback transaction is deferred and amortized over the lease term.
2. Operation Lease

a. Sales Price at Fair vale (general rule)
- Profit or loss is recognized immediately (NO Deferral)

b. Sales Price above Fair Value
- Profit is deferred and amortized over the expected to be used.

c. Sales Price below fair value
- Profit or loss is recognized immediately.

Question 27

**Exam trick - always note Dates

F5: Long-term Liabilities and Bonds Payable

*Convertible bonds

Answer 27

1. Convertible Bonds
   a. Nondetachable Warrants
   b. Detachable warrants
2. Term Bonds
   - Fixed maturity date
3. Serial Bonds

Question 28

**Overview of Bond Terms:

Answer 28

1. Usually in denominations of $1,000
2. Price is always quoted in 100’s (% of per value)
   - 101 - Bond is selling at premium
   - 98 - Bonds is selling at discount
3. Indenture is a contract for purchase of bond
4. Coupon rate = the stated interest rate on the bond
5. Bond interest (check amount) = coupon rate x face.
   Bonds generally pay interest semi-annually in the U.S. and annually in other countries.
6. Principal payoff is always the full face amount.
7. Premium/discount is the result of buyer and seller “adjusting” the coupon rate to the prevailing market rate of interest.

Question 29

**Accounting for the issuance of Bonds

Journal Entry:

Borrower: (Like Bond Seller)

Dr - Cash $1,000,000
Cr - Bond Payable $1,000,000

Investor: (Like Bond Buyer)

Dr - Investment in bonds $1,000,000
Cr - Cash $1,000,000

Answer 29

A. Bond Selling Price

1. Bonds issued at Par value

• Bond
• $1.000.000 - Face
• 10% (Coupon rate and market rate) - Coupon rate
• 5 years
• Semi-annual - every 6 months
• June 30 & December 31

$386,090 = $50,000x7.7218 “Annuity of $1 (10 periods at 5%”

$1,000,000 Net Present Value.

**Couponse * Face = Bond Interest (Check amount)

• *Fair Value of Bond
  1. PV of future interest payments (at market rate)

2. PV of principal (at market rate)
   - ———————————-

Question 30

**Bonds issue at a discount
(Low interest rate)

-meaning bond is paying low interested rate (10%) then market rate (12%)

Journal Entry:

Borrower:
Dr - Cash $926,395
DR - Discount on Bond payable $73,605
Cr - Bond Payable $1,000,000

Investor:
Dr - Investment bonds $926,395
Cr - Cash $926,395

Answer 30

Example - Low interest rate = Discount

• issued a 10%
• market rate is 12% annually (semi-annually 6%)

PV of $1 at 6% for 10 periods = 0.55839 = Principal

PV of an annuity of $1 at 6% for 10 periods = 7.36009 = Interest

$368,005 = $50,000 x 7.36009 “Annuity of $1 (10 periods @ 6%)”

$926,395
=================

Question 31

**Bond issued at a Premium (High interest rate)

• *Bond is paying high interest rate (10%) than market rate (8%).

Journal Entry:

Borrower
Dr - Cash $1,081,105
Cr - Premium on bond payable $81,105
Cr - Bond Payable $1,000,000

Investor:
Dr - Investment in bonds $1,081,105
Cr - Cash $1,081,105
———————————

Answer 31

Example: High Interest Rate = Premium

• Coupon rate = 10%
• Market rate is = 8%
• *Bond is paying better interest rate then market. so everybody will love the bond. People will bid for this bond

**PV of $1 at 4% (8%/2)for 10 (5 years x2 semi-annually) periods = 0.67556 = Principal

$405,545 = $50,000x8.11090 “Annuity of $1” (10 periods @ 4%)

$1,081,105

Question 32

**Stated Interest rate = Coupon rate = NOT Market rate

**The stated rate of a bond will not change, regardless of the market rate at the date of issuance.

Answer 32

**Coupon rate = NOT market rate

**Therefore, Premium or discount occurred on the buying of bond.

**Always be at the stated rate applied to the face amount on the bonds. that’s why payment is always $50,000

Question 33

**Effective Interest rate = Market rate

Answer 33

**Coupon rate adjusted for Premium or Discount rate.

Question 34

*Unamortized Discount

**Unamortized Premium

Answer 34

*Contra-account to bonds payable.

**Addition to the face (par) value.

Question 35

*Straight-Line Method

Answer 35

Step 1: Calculate Amortization

Amortization = Premium or discount/Number of periods bond is outstanding

Step 2:

Interest Expense = Check amount +/- Amortization

**Check amount = Face x coupon rate.

Question 36

Effective Interest Method = Constant yield method

**Effective Interest rate = Market rate.

Answer 36

I/S - B/S = Amortization

**Use of the effective interest method of accounting for the amortization of unamortized discounts/premiums is required by both U.S. GAAP and IFRS.

1. Interest Expense = Carrying value at the beginning of the period X Effective interest rate.
2. Discount/Premium Amortization

I/S: Net Carrying value x Effective interest rate = Interest Expense

Diff: Amortization

Question 37

F5: Present value of Annuity

Present value formula

Answer 37

Present Value = Future Amount x Present value factor

Therefore, Future Amount = Present vale / Present value factor

**The present value factor is the discount rate for 2 year = 0.826

Future amount = $10,000 /.826 = $12,107

Question 38

Question: What is the total amount of interest revenue that glade will earn over the life of the lease?

Answer 38

Answer: The fair value of the equipment is equal the present value of the future cash flows.

PV = Annual Rents (Payments) x Annuity due PV factor (n = 5, i =8%0

$323.400 = Annual rents x 4.312

Annnual rents = 75,000

Total cash flows = 5 x 75,000 = $375,000

Total Interest Revenue = $375,000 - $323,400 = $51,600

Question 39

**Nonrefundable lease bonus paid

Answer 39

**Since the lease bonus is nonrefundable, it represents income attributable to the lease term. Therefore, recognition is deferred and recognized over the life of the lease

**Recognition of revenue when cash is received (i.e. at the inception of the lease) violates normal accrual accounting procedures.

Question 40

Question: What amount should Mene (Lessee) report as Capital lease obligation, net of current portion?

Answer 40

Answer:

Step 1:

The lesser of the lessee’s incremental borrowing rate or the lessor’s implicit rate (If known) should be used, which is 10%.

Step 2:
The amortization of the lease is:

Date - Cash Pay -Interest Exp - Principal - Lease oblig
——– ————– —————— ———— —————-
12/31/Y1 $76,364
1/2/Y2 9,000 - 7,636 - 1,364 75,000
12/31/Y2 75,000
1/2/Y3 9000 - 7,500 - 1,500 73,500

Question 41

Question: What amount should oak report as capital (finance) lease liability in its December 31,Year 2, Balance sheet?

Answer 41

Answer: The initial amount capitalized is the present value using the lessor’s rate if known (10%). The following table shows the liability on 12/31/Year 2.

Date - Payment - Interest - Principal - Lease Liability
———- ———— ———— ———– ——————–
12/31/Y1 $316,5000
12/31/Y1 $50,000 50,000 $266,500
12.31/y2 $50,00 26,650 23,350 $234,150
——————————————————============

Question 42

Question: What amount should Neal report as capitalized (finance) lease liability at December 31, Year 1?

Answer 42

Answer: Capital (finance) leases should be recorded at the present value of the minimum lease payment (fair market value of property is not stated). The lease payment is used. Taxes should be expensed when paid.
therefore, $52,000 - 2,000 tax = $50,000

The present value of an ordinary annuity for 9 years at 9% = $50,000 x 5.6 = $280,000
==============

Question 43

Question: What amount of profit on the sale should Howe report for the year ended December 31, Year 1?

Answer 43

Answer: The excess of the present value of the selling price over its cost is recorded as profit.

Present value of payments: $3,300,000
Carrying cost on Howe’s books: (2,800,000)
————————————————————
Profit on Sale: $500,000

Question 44

Question: What amount should Nori recognize as depreciation expense on the leased asset?

Answer 44

Answer: When a lease is capitalized because of transfer of title, or bargain purchase option, depreciation is based on the life of the asset, not the lease.

**The Cost includes the bargain purchase price.

**Depreciation cannot be taken below the salvage value.

**Depreciation is: ($240,000 - $20,000)/8 = $27,500
===========

Question 45

Question: In its income statement for the current year ended June 30, what amount should Oren report as Rent Expense??

Answer 45

Answer: Rent expense should include the first month’s rent and an allocated portion of the bonus. The last month’s rent should be shown as a prepaid expense.

First month’s rent: $10,000
Amortize bonus ($30,000/60 ) = 500
——————————————————
Total rent expense for June 30: $10,500
============

Question 46

Question: What amount should Dirk report as deferred gain on these transactions under U.S. GAAP?

Answer 46

Answer: Because no present value information is given, we must assume that the Plane 1 lease is “major.” It qualifies as a capital lease because it meets the 75% test (8 year term out of 10 year life is 80%).

**In “major” sale-leasebacks, all gain is deferred. We must also assume that the Plane 2 lease is “minor” because it will be classified as an operating lease (it fails all “OWNS” tests). In “minor” sale-leasebacks there is no deferral.

Question 47

Question: Should JCK recognize rent or interest revenue in Year 3, and should the revenue recognized in Year 3 be the same or smaller than the revenue recognized in Year 2 under U.S. GAAP?

Answer 47

Answer: The lease is a capital lease (lease term is 80% of asset life).

**Interest revenue is recognized for a capital lease, based on the discount rate times the carrying value of the lease receivable.

**As time passes, the lease receivable decreases and interest revenue recognized also decreases.

Question 48

Question: What amount should Robbins record as lease liability at the beginning of the lease term?

Answer 48

Question:
Step 1:

The lessee should record the capital (finance) lease at the lower of:

1. Present value of minimum lease payments
   or
2. Fair Value (FV) of asset at the inception of lease. The FV is not given.

Step 2:

The interest rate is 12% (Lessor’s rate is used only if lower or the implicit rate is not known)

Step 3:

The lease payments begin immediately (annuity due basis).

Step 4:

The bargain purchase option must also be capitalized.

Step 5:

The Amount capitalized is:

Annual Payment, $10,000 x 6.328 = $63,280
Bargain Purchase Option: $10,000 x .322 = $3,220
—————————————————————————
Lease liability at the beginning of term: $66,500

**Factor used:

**The present value of an annuity due of 1 at: 12% for 10 years is 6.328

• *The present value of 1 at: 12% for 10 years is .322

Question 49

Question: What is the amount of profit on the sale and interest revenue that Howe should record for the year ended.

**Notice, lease inception period is July 1, Year 1.

Answer 49

Answer: $720,000 Profit on sale and $146,000 interest revenue.

**Rule 1: In a sales-type (finance) lease, any difference between the fair value of the leased asset and its carrying value is recognized as manufacturer’s or dealer’s profit.

Cash selling price of equipment: $3,520,000
Less Cost of equipment: (2,800,000)
——————————————————————-
Profit recognized on sale: $720,000
================

**Rule 2: Unearned interest revenue in a sales-type lease is amortized over the period of the lease using the interest method:

PV at inception of the lease at 7/1/Y1: $3,520,000
Less initial payment 7/1/Y1: (600,000)
————————————————————————-
Balance ending Year 1: (2,920,000)

Interest revenue from 7/1/Y1 to 6/30/Y2:$ 292,000
Adjust from full year to half year x 1/2
—————————————————————————-
Interest revenue for year end 12/31/Y1 : 146,000
=============

Question 50

Question: Using the straight-line method, what amount should Tell recognize as depreciation expense on the equipment in the current year?

Answer 50

Answer: The lessee records the lease as an asset and a liability at the lower (lesser) of the fair market value or the asset at the inception of the lease, or cost (present value of the minimum lease payments).

**Lease should be depreciated (amortized) over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option.

Present value of minimum lease payments: $505,000
/ lease term /9
—————————————————————————–
depreciation expense: $56,1111
=============

Question 51

Question: In Hooks’ December 31, Year 1, balance sheet, the unearned gain on equipment sale under IFRS should be?

Answer 51

Answer:
Rule: Any profit on a sale-leaseback which is classified as a capital (finance) lease should be deferred and amortized in proportion to depreciation taken on the leased-back asset.

Selling price: $150,000
Carrying value: (100,000)
—————————————
Gain to be deferred as of January 1, Year 1: $50,000 /10 = $5,000
Less amortization of gain for Year 1: (5,000)
——————————————————————
Deferred gain 12/31/Y1: $45,000
========

Question 52

Question: What amount of deferred gain on the sale should Mega report at December 31, Year 1?

Answer 52

Answer No gain is deferred. The leaseback will be classified as an operating lease because the lease does not transfer substantially all the risks and rewards inherent in ownership to the lease (the present value of the lease payments is not substantially all of the fair value of the leased asset and the lease term is not a major part of the economic life of the asset). When the lease in an IFRS sale-leaseback transaction is classified as an operation lease and the sales price is equal to the fair value of the leaseback asset, any profit or loss is recognized immediately.

Recongized gain = $400,000 - $300,000 = $100,000

Question 53

Question: What amount should Oak report as finance lease asset on its December 31, Year 2 Balance sheet?

Answer 53

Answer, On December 31, Year 1, this lease should be recorded at present value using the lower implicit rate of 10%.

Under IFRS, initial direct costs must be added to the finance lease asset at lease inception. This Lease would be recorded using the following JE:

Dr - Finance lease asset $319,500
Cr - Finance lease obligation $316,500
Cr - Cash 3,000

**The finance lease asset is then amortized over the lease term/useful like of 9 years:

**Annual Depreciation = $319,500 / 9 = $35,500

12/31/Y2, after recording one year of depreciation, the finance lease asset will be reported as:
Finance lease asset, 12/31/Y2 = Finance Lease asset , 319,500 - $35,500 (Year 2 depreciation)
=$284,000

Question 54

Question: In a sale-leaseback transaction accounted for under IFRS, a gain resulting from the sale should be deferred at the time of the sale-leaseback and subsequently amortized when:

Answer 54

1. The seller-lessee accounts for the lease as a finance lease.
2. The seller-lessee amounts for the lease as an operation lease and the sales price is above fair value.

**If the lease is classified as an operating lease and the sales price is equal to fair value, the gain is recognized immediately.

**If the lease is classified as an operation lease and he sales price is below fair value, the gain is recognized immediately.

Question 55

Queston: Able Co. leased equipment to Baker under a noncancellable lease with a transfer of title. Will able record depreciation expense on the leased asset and interest revenue related to the lease?

Answer 55

Answer: Baker, the lessee, will capitalize the lease (due to the transfer of title) and will incur both depreciation and interest expense. Able will earn and book interest income when the payments from Baker are received. Able will remove the asset from its books at the inception of the lease and will not depreciate the asset.

Question 56

Question: What are the components of the lease receivable for a lessor involved in a direct-financing lease?

Answer 56

Answer: The minimum lease payments plus residual value.

Question 57

Question: What amount should Dunn report as rent expense in its monthly income statement for April, Year 3?

Answer 57

Answer: Rent expense must be reported on a straight-line basis. When lease rates fluctuate and when reduced rent is given, the average lease rate must be computed. In this case, total rent expense over the life of teh is $234,000 ($36,000 + $54,000 + $72,000 + 72,000) and the average monthly rent $4,875.

Question 58

Question: Amortization of leasehold improvements for Year 2 should be?

Answer 58

Rule: Amortization of leasehold improvements should be over the life of the improvements or the remaining life of the lease, whichever is shorter.

**In this case, the lease term is equal to or less than each category of improvements, accordingly all improvements should be amortized over 10 years. Since there is uncertainty as to whether the lease will be renewed, the renewal option is not a factor.

**Sales Office 10 years $47,000
Warehouse 25 years 75,000
Parking lot 15 years 18,000
————————————————
$140,000 / 10 = $14,000/year
============

Question 59

Question: On its December 31, Year 1, financial statements, Quattro would display the following amounts in the indicated accounts under U.S. GAAP.

Answer 59

Answer: Quattro’s lease qualifies for treatment as a capital lease since its term exceeds 75% of the useful life of the asset (4/5 or 80%) . A liability (lease payable) will be recorded in the amount of the present value of the minimum lease payments and an asset will be recorded in either the same amount or at the fair market value of the asset, whichever is less. since the lease does not meet the ownership transfer or bargain purchase option criteria, the asset will be depreciated over the tern of the lease, not the life of the asset.

**Calculation:

Down payment due at singing: $10,000
Annual lease payments: $10,000
Present value of an annuity (8% x 4years) x3.312
——————————————————————
Lease Liability: $33,120

**Present value of minimum lease payments (asset) = $43,120
Depreciation period: 4 years
—————————————————————
Annual depreciation expense: $10,780
Six months depreciation: $5,390
============

Question 60

Question: A lease is classified as a capital lease because it contains a bargain purchase option. Over what period of time should the lessee amortize the leased property?

Answer 60

Answer: The economic life of the asset.

**Rule: With a capital lease, the lessee should amortize the leased property over the economic life of the asset when there is a bargain purchase option or when the lessee takes ownership of the asset at the end of the lease term.

Question 61

Question: The market price of a bond issued at a premium is equal to the present value of its principal amount…

Answer 61

Answer: And the present value of all future interest payments, at the market (effective) interest rate.

**To determine the market price of a bond, the present value of the principal is added to the present value of all interest payments, using the market interest rate.

Question 62

Question: What amount did Eagle receive from the bond issuance?

Answer 62

Answer: The cash collected equals:

Face: 600 x $1,000 = $600,000
issue at: 99%
————————————————
Bond issue proceeds: $594,000

Face: $600,000
Coupon x 10%
-------------------------
Annual Interest: $60,000
% Year;                   3/12
----------------------------------------
Accrued interest :    15,000
----------------------------------------
Total cash received:   $609,000
                               ==============

Question 63

**Effective Interest Method = Constant Yield Method

**In its June 30, Year 1 balance sheet, what amount should West report as bonds payable?

Answer 63

**Use of the effective interest method of accounting for the amortization of unamortized discounts/premiums is required by both U.S. GAAP and IFRS.

**Interest expense and amortization for the period is calculated as follows:

1. Interest Expense:

Interest Expense = Carrying value at the beginning of the period x effective interest rate

2. Discount/Premium Amortization

Income statement -> Net Carrying value x effective interest rate = interest expense

  I/S  - B/S =                                           Amortization
                                                            ============

Example:
Income statement Balance sheet $469,500
————————— ———————-
$469,500 $500,000
x 10% x 9%
————- ——————
$ 46,950 $45,000 = $1,950/2 = $975
———————-
$470,475
============

Question 64

Question: In its Year 1 income statement, what amount should Dome report as gain or loss from retirement of bonds?

Answer 64

Answer: A gain of $53,000 is recognized because the $665,000 book value of the debt ($600,000 face value plus $65,000 unamortized premium) is settled for $612,000 ($600,000 at 102). There is no accrued interest because the redemption takes place on an interest date. The proceeds from the new bond issuance are not relevant.

Note: that the gain is reported as part of continuing operations because the transaction is a typical risk-management strategy of the company.

Question 65

Question: What amount should Moss record as discount or premium on issuance of bonds?

Answer 65

Answer: a. 110,000 discount
JE;

Dr. Cash - $1,090,000
Dr. Discount on Bond - 110,000
Cr. Bond Payable - 1,000,000
Cr. APIC - Warrants - 200,000

Question 66

Question: What amount of accrued interest payable should Beau report in its September 30, Year 2 balance sheet?

Answer 66

Answer, Accrued interest payable on September 30, Year 2 is the interest owed since the June 30, Year 2 payment.

**$300,000 x 12% x 3/12 = 9,000

Question 67

Question: In its December 31, Year 1, balance sheet, what amount should Fort report as bonds payable?

Answer 67

Answer: c. $900,000

**The net bonds payable is $1,000,000 less $100,000 or $900,000.

**The issuance of bonds with detachable stock warrants would be recorded as:

Dr. Cash $1,000,000
Dr. Discount - 100,000
Cr. Paid-in-capital, warrants - $100,000**
Cr. Bonds Payable - 1,000,000

**120,000/(1,080,000 + $120,000) = 10%

10% x 1,000,000 = 100,000

• *Note:
  1. The bonds would have a contra account for the discount
  2. The value of the warrants and bonds are used to determine the net bonds payable.

Question 68

Question: Bond issue costs were $250,000. What amount of bond issue costs are unamortized at June 30,Year 2 under U.S. GAAP?

Answer 68

Answer: Bond issue costs are recorded as deferred charges, and amortized over the life of the related debt.

**Amortization usually follows the straight-line method. Amortization for 1 and 1/2 years should have been recorded.

Balance 1/2/y1: $250,000
Amortization (250,000 x 1/10 x 1 1/2 yr) : (37,500)
——————————————-
unamortized balance 6/30/Y2: $212,500

**Unamortied balance: Yet to be amortized. is not Amortized yet.

Question 69

Question: Assuming annual interest payments, what amount of unamortized premium on bond should Webb report in its June 30, Year 3, balance sheet?

Answer 69

Answer: c. $4300

**The unamortized premium is amortized over the life of the bond using the 6% yield rate.

**The following chart shows the unamortized premiums:

Date - Int/Ex - Int/Pa - Pre - Una
------ ---------------------------------------
6/30/Y2:                           $5000
6/30/Y3: 6300 7000 700 4300
Note: $6,300 =

Carrying amount of note at beginning of period $ 105,000

Interest Expense for period: $6300
========

Note:
1. The unamortized premium is amortized over the life of the bond using the 6% yield rate.

2. The effective interest, not straight-line, method is being used.

**I/S - B/S = Amortization
I/S -> Net Carrying Amt x effective interest rate = Inter Exp
B/S -> Face amount x Coupon rate = Interest Paid.

Question 70

Question: What is the net amount that Tory should use in computing the gain or loss on retirement of debt?

Answer 70

Answer: C. $248,000

**The amount used to compute a gain or loss on bond retirement is the carrying amount of the bond and the pro rata potion of bond issue cost.

Original Carrying amount $500,000
Bond issue cost ($6000 - 5/15 x 6000) = (4,000)
———————————————-
Net Carrying amount on 6/2/Y6:
$496,000
Portion Retired: x 50%
—————————————
Amount used to compute gain/loss: $248,000
===========

**Note:
Total bond issue cost balance remian on 6/2/Y6 is:
$6,000 - $6,000x5/15 = $4000

Question 71

Question: What is the difference between Debt (e.g. Bond) and Equity(e.g. Stock) securities?

Answer 71

Debt securities are the legal obligation to repay borrowed funds at the maturity date. For example, commercial paper, bonds etc. Borrower pays interest however, interest expense is tax deductible.

Equity securities are the ownership interest for a company. For example, common and preferred stock. Owner receives dividends.

Question 72

Question: Which of the following is generally associated with the terms of convertible debt securities?

Answer 72

Answer: An interest rate that is lower then nonconvertible debt.

Question 73

Question: Logan declared and issued a 2% stock dividend

Answer 73

Answer: A stock dividend merely reclassifies amounts from Retained Earnings to Common Stock and APIC at the fair value of the declaration date.

Dr. Retained Earnings
Cr. Common Stock
Cr. APIC.