Module 4 Quiz

Question 1

What is an advantage of leasing?

Answer 1

Leases offer protection against obsolescence.

Question 2

Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2021, it leased equipment with a cost of $480,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments of $175,820 at the end of each year. The equipment has an expected useful life of 5 years. Silver Point’s incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $780,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is Silver Point’s book value of the leased asset at December 31, 2021?

Answer 2

$468,000

Because the lease term is equal to the expected economic life of the asset, this is a finance lease. Silver Point record the asset at the sales price of $780,000 less depreciation in 2021. 100% divided by 5 years is 20% per year or 40% using a double-declining balance method. Therefore, Silver Point’s book value is: [$780,000 - (780,000 x 40%)] = $468,000.

Question 3

In a finance lease, what does the lessee record?

Answer 3

Amortization expense and interest expense

Question 4

Metcalf Company leases a machine from Vollmer Corp. under an agreement that meets the criteria to be a finance lease for Metcalf. The six-year lease requires payment of $170,000 at the beginning of each year, including $25,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor’s implicit rate is 8% and is known by the lessee. The present value of an annuity due of $170,000 for six years at 8% is $848,761. The present value of an annuity due of $170,000 for six years at 10% is $814,435. The present value of an annuity due of $145,000 for six years at 8% is $723,943. The present value of an annuity due of $145,000 for six years at 10% is $694,664.

At which value should Metcalf record the leased asset?

Answer 4

$848,761

The lessor sets the terms of the lease and, therefore, the lessor’s rate of 8% is used. Metcalf’s lease payable will include amounts associated with maintenance, insurance, and taxes. Those amounts would be expenses in the period the payment is made. Therefore, Metcalf should report the leased asset on its balance sheet at $848,761.

Question 5

For a lessee with a finance lease containing a bargain purchase option, what is the lease asset depreciated over?

Answer 5

The asset’s remaining economic life