Leases Flashcards
Which of the follow statements regarding the lessor’s accounting under an operating lease is most accurate?
A refundable security deposit is booked as a liability until refunded.
If a security deposit is refundable to the lessee, the lessor has to book the deposit as a liability until the point it is returned to the lessee
Glade Co. leases computer equipment to customers under direct-financing leases.
The equipment has no residual value at the end of the lease, and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a 5-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for 5 years is 4.312.
What is the total amount of interest revenue that Glade will earn over the life of the lease?
A. $51,600
B. $75,000
C. $129,360
D. $139,450
A. 51,600
Int Rev is total CFs less PV CFs
PV = annual pmts x PVAD factor
323400 = pmt x 4.312
323400 / 4.312 = 75,000 annual pmt
75,000 X 5 yrs = 375000
375000 - 323400 = 51600
Lease A does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases?
Lease A: FINANCE LEASE
Lease B: FINANCE LEASE
both leases have terms equal to or more than 75% of their estimated economic life; therefore, both are finance leases under GAAP
At the inception of a finance lease, the guaranteed residual value should be:
included as part of minimum lease payments at present value
Guaranteed residual value is an additional lease payment, its full value must be included in the calculation o the minimum lease payments
A six-year capital lease entered into on December 31, Year 1, specified equal minimum annual lease payments due on December 31 of each year. The first minimum annual lease payment, paid on December 31, Year 1, consists of which of the following? Interest expense Lease liability a. Yes Yes b. Yes No c. No Yes d. No No
C. Int exp - no, Lease liability - yes
The debt was incurred on December 31, Year 1. The initial payment was made on December 31, Year 1. No interest expense is recognized since no time has passed between when the debt was incurred and the payment was made. Thus, the full amount of the payment reduces the lease liability.
Bain Co. entered into a 10-year lease agreement for a new piece of equipment worth $500,000. At the end of the lease, Bain will have the option to purchase the equipment. Which of the following would require the lease to be accounted for as a capital lease?
A. The lease includes an option to purchase stock in the company.
B. The estimated useful life of the leased asset is 12 years.
C. The present value of the minimum lease payments is $400,000.
D. The purchase option at the end of the lease is at fair market value.
B. The estimated useful life of the leased asset is 12 years.
Criteria:
Transfer of ownership at end
Bargain purchase option reasonably certain to excercise
Lease term is 75% or more of estimated economic life
PV of minimum lease payments is at least 90% of FV of asset
No alt use/specialized
On April 1, Year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a 4-year operating lease. Hall normally charges $6,000 per month to lease its gym, but as an incentive, Hall gave Dunn half off the first year’s rent and one quarter off the second year’s rent. Dunn’s rental payments were as follows:
Year 1: 12 × $3,000 = $36,000
Year 2: 12 × $4,500 = $54,000
Year 3: 12 × $6,000 = $72,000
Year 4: 12 × $6,000 = $72,000
Dunn’s rent payments were due on the first day of the month, beginning on April 1, Year 1. What amount should Dunn report as rent expense in its monthly income statement for April, Year 3?
$4,875
lease expense must be reported on SL basis. When leases fluctuate and when reduced costs given, avg lease rate must be computed.
total lease expense per life if The annual rent before incentives is 234,000 ($36,000 + $54,000 + $72,000 + $72,000) and avg expense is 58,500 (243000/4 years). avg expense of 58,500/12 months is 4,875 per month.
Peg Co. leased equipment from Howe Corp. on July 1 of the current year for an 8-year period. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1 of the current year. The rate of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe’s accounting records is $2,800,000. The lease is appropriately recorded as a sales-type lease. What is the amount of profit on the sale and interest revenue that Howe should record for the current year ended December 31?
A. Profit on sale, $720,000; Interest revenue, $176,000
B. Profit on sale, $720,000; Interest revenue, $146,000
C. Profit on sale, $45,000; Interest revenue, $176,000
D. Profit on sale, $45,000; Interest revenue, $146,000
B. Profit on sale, $720,000; Interest revenue, $146,000
When accounting for a lease from the perspective of the lessor, one needs to decide if the lease is sales-type, direct financing, or operating. In a sales-type lease, there can be an element of gross profit recognized by the lessor at the beginning of the lease, generally based on the difference between the sales price and the cost of the item to the lessor.
Here that gross profit recognized immediately is $720,000, the difference between the selling price and the cost of the equipment ($3,520,000 – $2,800,000). After the first payment is received, the remaining lease obligation will be paid like a long-term liability, with interest accruing on the unpaid balance. The unpaid balance for the first year is generally the difference between the selling price and the rent payment (when the payment is made at the start of the year). The unpaid balance for interest to accrue on is thus $2,920,000 ($3,520,000 – $600,000). The interest accrues from the payment in July to the end of the year, thus $146,000 ($2,920,000 × 0.1 × 6/12).
On January 2, 2004, Nori Mining Co. (lessee) entered into a 5-year lease for drilling equipment.
Nori accounted for the acquisition as a capital lease for $240,000, which included a $10,000 bargain purchase option. Nori expected to exercise the bargain purchase option at the end of the lease. Nori estimated that the equipment’s fair value would be $20,000 at the end of its 8-year life. Nori regularly uses straight-line depreciation on similar equipment.
For the year ending December 31, 2004, what amount should Nori recognize as depreciation expense on the leased asset?
A. $48,000
B. $46,000
C. $30,000
D. $27,500
D. $27,500
When a lease is capitalized b/c of transfer of title or written purchase option, deprec is based on life of asset, not lease. Deprec cannot be taken below SV.
The lessee capitalizes the full $240,000 including the bargain purchase option because that amount is expected to be paid and is thus included in the cost of the asset at present value. The asset becomes the property of the lessee at the end of the lease term.
($240,000 - $20,000)/8 = 27,500
On December 30, 2004, Rafferty Corp. leased equipment under a capital lease. Annual lease payments of $20,000 are due December 31 for 10 years.
The equipment’s useful life is 10 years, and the interest rate implicit in the lease is 10%. The capital lease obligation was recorded on December 30, 2004 at $135,000, and the first lease payment was made on that date.
What amount should Rafferty include in current liabilities for this capital lease in its December 31, 2004 balance sheet?
A. $6,500
B. $8,500
C. $11,500
D. $20,000
B. $8,500
The lease liability at the end of year 1 is $115,000 ($135,000 - $20,000) because the first payment has been made and it consisted only of principal.
The entry to be made at the end of Y1 will be:
Interest expense .10($115,000) 11,500
Lease liability 8,500
Cash 20,000
The amount of the lease liability to be extinguished in the next year( to be included in current liabilities) is $8,500 as shown in the entry since that amount is due within 1 year of the balance sheet date.
On January 1, Blaugh Co. signed a long-term lease for an office building. The terms of the lease required Blaugh to pay $10,000 annually, beginning December 30, and continuing each year for 30 years. The lease qualifies as a capital lease. On January 1, the present value of the lease payments is $112,500 at the 8% interest rate implicit in the lease. In Blaugh’s December 31 balance sheet, the capital lease liability should be A. $102,500 B. $111,500 C. $112,500 D. $290,000
B. $111,500
A lease payment has two components: interest expense and the portion applied to the reduction of the lease obligation. The effective-interest method requires that the carrying amount of the obligation at the beginning of each interest period be multiplied by the appropriate interest rate to determine the interest expense. The difference between the minimum lease payment and the interest expense is the amount of reduction in the carrying amount of the lease obligation. Consequently, interest expense is $9,000 ($112,500 BOY liability balance × 8% implicit rate), and the reduction in the lease obligation is $1,000 ($10,000 cash – $9,000 interest expense). The new balance of the lease obligation is thus $111,500 ($112,500 – $1,000).
In the long-term liabilities section of its balance sheet at December 31, Year 1, Mene Co. reported a capital lease obligation of $75,000, net of current portion of $1,364. Payments of $9,000 were made on both January 2, Year 2, and January 2, Year 3. Mene’s incremental borrowing rate on the date of the lease was 11% and the lessor’s implicit rate, which was known to Mene, was 10%. In its December 31, Year 2, balance sheet, what amount should Mene report as capital lease obligation, net of current portion?
a. $73,500
b. $74,250
c. $66,000
d. $73,636
a. 73500
At December 31, 20X1, the total lease liability was $76,364 (the sum of the current portion of $1,364 and the long-term portion of $75,000).
The $9,000 payment made on January 2, 20X2, was for the $1,364 current portion and the interest of $7,636 ($9,000 – $1,364). After the January 2, 20X2, payment, the total lease liability is $75,000.
Interest for 20X2 is $7,500 ($75,000 × 10% implicit rate). Therefore, the reduction in principal that will be included in the January 2, 20X3, payment will be $1,500, which is the $9,000 payment minus $7,500 interest for 20X2.
This $1,500 represents the current portion of the lease liability. Therefore, the long-term portion of the liability at December 31, 20X2, is the $75,000 total lease liability less the $1,500 current portion, or $73,500.
On December 29, Action Corp. signed a 7-year capital lease for an airplane to transport its sports team around the country. The airplane’s fair value was $841,500. Action made the first annual lease payment of $153,000 on December 31. Action’s incremental borrowing rate was 12%, and the interest rate implicit in the lease, which was known by Action, was 9%.
The following are the rounded present value factors for an annuity due:
9% for 7 years 5.5
12% for 7 years 5.1
What amount should Action report as capital lease liability in its December 31 balance sheet?
A. $841,500
B. $780,300
C. $688,500
D. $627,300
C. $688,500
Action must use the 9% rate because it is the lower of the two and Action knows the lessor’s implicit rate of 9%.
The initial capitalized value is $153,000 times the present value of a 7-year annuity due because the first payment is due at inception. Multiplying the 5.5 factor by $153,000 yields the fair value of $841,500, the initial capitalized value before the first payment.
After the first payment was made, which is all principal because it was made at the inception, the remaining lease liability is $688,500 ($841,500 - $153,000).
During January Year 1, Yana Co. incurred landscaping costs of $120,000 to improve leased property.
The estimated useful life of the landscaping is fifteen years. The remaining term of the lease is eight years, with an option to renew for an additional four years. However, Yana has not reached a decision with regard to the renewal option.
In Yana’s December 31 Year 1 balance sheet, what should be the net carrying amount of landscaping costs?
A. $0
B. $105,000
C. $110,000
D. $112,000
B. $105,000
Amortization of leasehold improvements should be over the life of improvements or remaining life of lease, whichever is shorter.
Since uncertainty around renewal of lease, renewal option is not factor.
120,000/8 yrs = 15,000 per year
Balance at 1/1/Y1 1200000 - Y1 amortization 15,000 = 105,000
On January 1, a company enters into an operating lease for office space and receives control of the property to make leasehold improvements. The company begins alterations to the property on March 1 and the company's staff moves into the property on May 1. The monthly rental payments begin on July 1. The recognition of rental expense for the new offices should begin in which of the following months? A. January. B. March. C. May. D. July.
A. January.
Lessee should begin recognition of lease expenses for new office in Jan, as this is commencement date. Commencement date is the date underlying asset is made available to the lessee for use and when the company entered into the lease. Lease expense is recorded over the lease term.
