Leases Flashcards
On January 1, year 1, a shipping company sells a boat and leases it from the buyer in a sale-leaseback transaction. At the end of the 10-year lease, ownership of the boat reverts to the shipping company. The fair value of the boat, at the time of the transaction, was less than its undepreciated cost. Which of the following outcomes most likely will result from the sale-leaseback transaction?
Losses are recognized immediately in a sales-leaseback transaction. When the shipping company sold the boat, its fair value was below its undepreciated cost, and the loss is recognized immediately.
On January 1, 20X0, JCK Co. signed a contract for an eight-year lease of its equipment with a 10-year life. The present value of the 16 equal semiannual payments in advance equaled 85% of the equipment’s fair value. The contract had no provision for JCK, the lessor, to give up legal ownership of the equipment. Should JCK recognize rent or interest revenue in 20X2, and should the revenue recognized in 20X2 be the same or smaller than the revenue recognized in 20X1?
Since the 8-year lease term exceeds 75% of the equipment’s 10-year useful life, JCK will record the lease as a sales-type or direct financing lease.
As such, JCK will recognize an interest bearing receivable. Each payment received will be allocated to interest first with the remainder allocated to reducing the principal balance of the receivable.
Since the principal balance is reduced each period, the amount allocated to interest will decrease each period.
As a result, JCK will recognize interest revenue and the amount will decrease each year.
Jay’s lease payments are made at the end of each period. Jay’s liability for a capital lease would be reduced periodically by the
Minimum lease payment less the portion of the minimum lease payment allocable to interest.
On July 1, 20X2, South Co. entered into a ten-year operating lease for a warehouse facility. The annual lease payments are $100,000. In addition to the base rent, South pays a monthly allocation of the building’s operating expenses, which amounted to $20,000 for the year ended June 30, 20X3. In the notes to South’s June 30, 20X3, financial statements, what amounts of subsequent years’ lease payments should be disclosed?
$100,000 per annum for each of the next five years and $900,000 in the aggregate.
When a lessee enters into an operating lease, required disclosures will include:
the minimum lease payments for each of the five years subsequent to the balance sheet date
the sum of the minimum lease payments due later than five years from the balance sheet
the full aggregate obligation amount, which is the sum of the previous two items
Here, the answer requires the yearly amount for each of the next five years and the full aggregate obligation amount.
The amount to be reported does not include amounts paid for operating expenses or executory costs. In South’s financial statements dated 6/30/X3, one year of the 10-year lease had elapsed. As a result, South would disclose the rents for each of the next 5 years at $100,000 per year and $400,000 for the remaining years, for an aggregate (i.e., total) amount of $900,000 [($100,000 × 5) + $400,000].
On January 2, 20X2, 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 includes a $10,000 bargain purchase option. At the end of the lease, Nori expects to exercise the bargain purchase option. Nori estimates that the equipment’s fair value will be $20,000 at the end of its 8-year life. Nori regularly uses straight-line depreciation on similar equipment. For the year ended December 31, 20X2, what amount should Nori recognize as depreciation expense on the leased asset?
Fair value at the end of the life = salvage value
so 240,000 - 20,000 / 8 years = 27500
this is the amount of depreciation expense for the year
Since the lease contains a bargain purchase option, which Nori expects to exercise, the equipment will be depreciated over its useful life of 8 years. The amount to depreciate will be the capitalized amount of $240,000 minus the salvage value of $20,000 for a depreciable basis of $220,000. Depreciation in 19X2 will be $220,000/8 years or $27,500.
Main, a pharmaceutical company, leased office space from Ash. Main took possession and began to use the building on July 1, 20X0. Rent was due the first day of each month. Monthly lease payments escalated over the 5-year period of the lease as follows:
Period Lease payment July 1, 20X0 - September 30, 20X0 $0 - rent abatement during move-in, construction October 1, 20X0 - June 30, 20X1 17,500 July, 1, 20X1 - June 30, 20X2 19,000 July 1, 20X2 - June 30, 20X3 20,500 July 1, 20X3 - June 30, 20X4 23,000 July 1, 20X4 - June 30, 20X5 24,500
Rent expense must be recognized evenly over the lease term. Total rent will be (9 x $17,500 + 12 x $19,000 + 12 x $20,500 + 12 x $23,000 + 12 x $24,500), or $1,201,500. Dividing the total rent by the total number of months gives the uniform monthly rent expense of $20,025 (1,201,500 / 60 = 20,025). As of December 31, 20X3, 3 years and 6 months have elapsed, indicating cumulative rent expense of (42 x $20,025), or $841,050. Only (9 x $17,500 + 12 x $19,000 + 12 x $20,500 + 6 x $23,000), or $769,500 had been paid. Deferred rent expense of $71,550 is calculated by comparing rent expense recognized as of 31 Dec 20X3 with actual rent paid as of 31 Dec 20X3 (841,050 – 769,500 = 71,550).
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?
An operating lease generally takes effect when the lessee assumes control over the leased property, which is not always contemporaneous with the first lease payment. Because the lessor company received control on January 1, it will recognize rental expense beginning in January. Rental expense will be recognized uniformly over the lease term, with the monthly rental expense equaling the total rent to be paid during the lease term divided by the total number of months in the lease term.
On April 1, year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a four-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 x $3,000 = $36,000
Year 2 12 x $4,500 = $54,000
Year 3 12 x $6,000 = $72,000
Year 4 12 x $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?
Rent expense must be recognized evenly over the lease term. Dividing the total rent by the total number of months gives the uniform monthly rent expense of $4,875 ((36,000 + 54,000 + 72,000 + 72,000) / 48 = 4,875).
Douglas Co. leased machinery with an economic useful life of six years. For tax purposes, the depreciable life is seven years. The lease is for five years, and Douglas can purchase the machinery at fair market value at the end of the lease. What is the depreciable life of the leased machinery for financial reporting?
The lease is a capital lease because the lease term of 5 years is more than 75% of the 6 year useful life. Because this is a capital lease with no title transfer and no bargain purchase option, for financial reporting the lessee must depreciate the asset over the shorter of either the economic useful life (six years) or lease term (five years).
Jarvis Company leased a new machine beginning on January 1, 20X1. The lease, which has an interest rate of 6%, is for 5 years and requires annual payments of $10,000 on each December 31. The present value of an ordinary annuity of $1 at 6% for 5 periods is 4.212. Title to the machine remains with the lessor. The machine, which cost the lessor $30,000, has a useful life of 6 years and will be depreciated on a straight-line basis. What will be the carrying value of the machine at December 31, 20X2?
Because the lease is for 5 years, it is for more than 75% of the machine’s 6 year useful life and will be accounted for as a sales type lease by the lessor, removing it from the lessor’s books, and as a capital lease by the lessee. It will be recognized as an asset in the amount of $42,120 ($10,000 x 4.212) and depreciated over the 5 year term of the lease since title does not transfer to the lessee and there is no indication of a bargain purchase option. Depreciation is $8,424 per year, or $16,848 for the 2 years ending 12/31/X2, resulting in a carrying value of $25,272 on the lessee’s books.
What are the components of the lease receivable for a lessor involved in a direct-financing lease?
When calculating the lease receivable for a direct-financing lease, the lessor will include the minimum lease payments and the asset’s residual value.
A company leases a machine from Leasing, Inc. on January 1, year 1. The lease terms include a $100,000 annual payment beginning January 1, year 1. The machine’s fair value is $500,000 and the residual value is estimated at $20,000. The company guarantees the residual value. The useful life of the machine is six years, and the lease term is five years. The implicit rate of interest is 6% and is known by the company. The following present value factors are provided:
Five years Six years Present value of $1 at 6% 0.7473 0.7050 Present value of an annuity due at 6% 4.4651 5.2124 Present value of an ordinary annuity at 6% 4.2124 4.9173
What is the value of the machine in the company’s balance sheet at lease inception?
With a lease term equal to 5 years of the asset’s 6 year useful life, the lease is a capital lease and will result in the recognition of an asset and a liability equal to the present value of the minimum lease payments. Five annual $100,000 payments made at the beginning of each year is an annuity due with a present value of $100,000 x 4.4651 or $446,510. The guaranteed residual value is a single payment due at the end of the lease, five years from its inception, resulting in a present value of $20,000 x 0.7473 or $14,946. The total amount to be recorded will be $446,510 + $14,946, or $461,456.
A six-year capital lease that specifies equal minimum annual lease payments expires on December 31st. The payments being made represent both interest and a reduction in the net lease liability. The portion of the minimum lease payment in the fifth year applicable to the reduction of the net lease liability should be:
Payments made on a capital lease are first applied to interest with the remainder reducing the lease obligation. As the lease obligation declines each year, the amount recognized as interest expense also decreases. When lease payments are equal, as the interest portion declines, the principal reduction increases. As a result, the principal reduction in the fifth year would be greater than the fourth year and smaller than the reduction in the sixth year.
On December 31, 20X2, Dirk Corp. sold Smith Co. two airplanes and simultaneously leased them back. Additional information pertaining to the sale-leasebacks follows:
Plane #1 Plane #2
Sales price $600,000 $1,000,000
Carrying amount, 12/31/X2 $100,000 $550,000
Remaining useful life, 12/31/X2 10 years 35 years
Lease term 8 years 3 years
Annual lease payments $100,000 $30,000
In its December 31, 20X2, balance sheet, what amount should Dirk report as deferred gain on these transactions?
500,000
In the lease on plane #1, the seller-lessee retains substantial risks and rights in relation to the plane and the gain of $500,000 would be deferred. In the lease on plane #2, the 3 years rent at $30,000 per year represents less than 10% of the $1,000,000 sales price of the property. It is a minor leaseback and Dirk will recognize the gain of $450,000. The total gain to be deferred by Dirk would be $500,000.
On December 30, 20X1, 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, 20X1, 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, 20X1, balance sheet?
The lease obligation, recorded at the inception of the lease was $135,000. This would have been reduced by the initial $20,000 payment, made at the inception of the lease, resulting in an obligation of $115,000 at 12/31/X1. The payment on 12/31/X2 will consist of interest at 10% of $115,000 or $11,500. The remaining $8,500 will reduce the lease obligation in 20X2. As a result, $8,500 will be reported as a current liability, current portion of long-term debt, and the remaining $106,500 will be reported as noncurrent.
