Section 3F - Leases Flashcards
On December 30, 20X1, Rafferty Corp. leased equipment under a finance 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 finance 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 lease in its December 31, 20X1, balance sheet?
$8,500
$6,500
$11,500
$20,000
$8,500
The lessee is required to recognize a lease liability equal to the ___of the lease payments. Lease payments consist of the following:
- Fixed payments T/F
- Variable lease payments that depend on an __ or a __
- The exercise price of an ___to purchase the underlying asset if the lessee is reasonably certain to exercise the option
- Payments for penalties for ___the lease,
- __paid by the lessee to the owners of a special-purpose entity for structuring the transactions
- For lessees only, amounts probable of being owed by the lessee under residual value __
present value
true
index or a rate
option
terminating
Fees
guarantees
Initial measurement of the right-of-use (ROU) asset includes the following:
The initial ___of the lease liability
Any lease payment made ___ or ___the lease commencement date, less any ___received
Any initial ___incurred by the lessee (e.g., commissions or termination incentive payments). Costs paid that would have been paid irrespective of the lease are not considered initial ___costs.
If a lessee classifies the lease as a ___lease due to transfer of ownership or if the lessee is reasonably ____to exercise the option, ___over the ROU asset life instead of the shorter of the lease term or ROU asset life.
measurement
at or before , incentives
direct costs
finance , certain, amortize
On June 30 of the current year, Lang Co. sold equipment with an estimated useful life of 11 years and immediately leased it back for 10 years. The equipment’s carrying amount was $450,000; the sales price was $430,000; and the present value of the lease payments, which is equal to the fair value of the equipment, was $465,000. In its June 30 current-year balance sheet, what amount should Lang report as deferred loss?
$35,000
$15,000
$0
$20,000
$0
The first step is to determine if this transaction qualifies as a sale. Per FASB ASC 842-40-25-2, a sale has not occurred if the leaseback could be classified as a finance lease or a sales-type lease.
Since the lease term is 10/11 = 90.1% of the asset’s economic life, this does not qualify for sale/leaseback treatment. Lang will not derecognize the asset and will recognize the consideration received as a financial liability.
Sale and leaseback transactions generally involve ___assets, typically real estate or significant capital items such as airplanes, and are usually entered into because they provide financing, accounting, or tax benefits.
If an entity (the transferor) transfers an asset to another entity (the transferee) and leases that asset back from the transferee, both the transferor and the transferee should account for the transfer contract and the lease in accordance with FASB ASC 842. T/F
fixed
true
Recognition
In accounting for the ___, if a sale has in fact occurred, the seller/lessee and the buyer/lessor account for the leaseback in the ___as any other lease.
The buyer/lessor is determined to not have obtained control of the underlying asset if the leaseback is classified as a ___ or ___ lease, assessed from the seller/lessee’s perspective. Accordingly, no sale has been deemed to have occurred.
A repurchase option for the seller/lessee exercisable only at the then-prevailing fair market value would not preclude sale treatment, provided that the underlying asset is nonspecialized and readily available in the marketplace. The repurchase option must be substantive in order to affect the accounting for the transaction.
leaseback, same manner
finance or sales-type
Transfer of the Asset Is Not a Sale
If a transfer of the asset is not accounted for as a sale of the asset, the seller/lessee should not derecognize the transferred asset and should account for any amounts received as a financial liability; conversely, the buyer/lessor should not recognize the transferred asset and should account for the amounts paid as a receivable. T/F
true
On August 1 of the current year, Kern Company leased a machine to Day Company for a 6-year period requiring payments of $10,000 at the beginning of each year. The machine cost $48,000, which is the fair value at the lease date, and has an estimated life of eight years with no residual value. Kern’s implicit interest rate is 10% and present value factors are as follows:
- Present value of an annuity due of $1 at 10% for 6 periods: 4.791
- Present value of an annuity due of $1 at 10% for 8 periods: 5.868
Kern appropriately recorded the lease as a sales-type lease. At the commencement of the lease, before any payments, the lease receivables account balance should be:
$60,000.
$47,910.
$58,680.
$48,000.
$47,910.
When a lessor is recognizing a lease transaction as a sales-type lease, the lessor creates an account for the net investment in the lease which is comprised of the lease receivable and any unguaranteed residual value. This account keeps track of the lease rental payments to be received by the lessor.
Here the net investment in the lease balance at the beginning of the lease is all six payments of $10,000 multiplied by 4.791, or $47,910.
The first set of criteria result in a finance lease for a lessee or sales-type lease for the lessor if the lease meets any of the following criteria at commencement:
___transfers to the lessee by the end of the lease term.
The lease contains a ___that the lessee is reasonably certain to exercise.
The lease term is for the major part of the ___of the underlying asset.
The present value of the sum of the lease payments and any lessee guaranteed residual value not already in the lease payments __ or ___ substantially all of the fair value of the underlying asset.
The underlying asset is ___and is not expected to have an ___to the lessor at the end of the lease term.
Title
purchase option
remaining economic life
equals or exceeds
specialized , alternative use
Sales-type leases:
at commencement, recognize the net ___in the lease [lease receivable (lease payments plus guaranteed residual values) plus the unguaranteed residual asset (RA)]; derecognize the ___of the underlying asset; and recognize sales revenue and cost of goods sold at the beginning of the lease such that selling profit (usually when the fair value of the asset exceeds the cost or book value of the asset) if any, is immediately recognized. Expense initial direct costs if a selling profit exists and defer initial direct costs by increasing the net investment in the lease if there is zero profit.
subsequent to commencement, recognize ___income (interest on the lease receivable and interest from the unguaranteed residual asset accretion) using the ___interest method and reduce the net investment in the lease.
investment, carrying amount
interest , effective
Oak Co. leased equipment for its entire 9-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, 20X1, and $50,000 annually on each December 31 for the next eight years. The present value on December 31, 20X1, of the nine lease payments over the lease term, using the rate implicit in the lease which Oak knows to be 10%, was $316,500.
The December 31, 20X1, present value of the lease payments using Oak’s incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as the finance lease liability in its December 31, 20X2, balance sheet?
$350,000
$0
$228,320
$243,150
$243,150
Both lessees and lessors discount lease payments at the ___date using the rate ___in the lease.
Per FASB ASC 842, the rate implicit in the lease is the rate of interest that causes the aggregate present value of the lease payments, and the amount that the lessor expects to derive from the underlying asset following the end of the lease term, to equal the sum of:
- the fair value of the underlying asset minus any related investment __retained and expected to be realized by the lessor, and
- any deferred initial ___of the lessor.
In essence, it is the rate that makes the lessor ___in its investment in the leased asset, after discounting the lease payments and residual value to their present value.
lease commencement, implicit
tax credit
direct costs
whole
The lessee can use its ___rate for purposes of discounting its lease payments if the lessee does not know the rate implicit in the lease.
The ___rate is defined as the interest rate a lessee would have to pay to borrow on a ___basis over a similar term the amount equal to the lease payments, assuming similar economic conditions.
incremental borrowing
incremental borrowing, collateralized
FASB ASC Topic 842, Leases, is intended to improve the quality and comparability of financial reporting by providing greater transparency about:
All of the answer choices are correct.
l___
the ___to which it is exposed to from entering into leasing transactions.
the ___an organization uses in its operations.
All of the answer choices are correct.
leverage.
risks
assets
FASB Accounting Standards Update (ASU) 2016-02 describes improvements to accounting and disclosures for leverage, asset composition, and risk.
Cady Salons leased equipment from Smith Co. on January 1, 20X1, in an operating lease. The present value of the lease payments discounted at 10% was $80,000. Ten annual lease payments of $12,000 are due at each January 1 beginning January 1, 20X1. The amortization of the right-of-use asset for the reporting year ending December 31, 20X1, would be:
$6,800.
$8,000.
$12,000.
$5,200.
$5,200.
In an operating lease, the lessee amortizes its right-of-use asset at an amount so that the total of interest expense and amortization will be a straight-line amount equal to the annual payments ($12,000 per year). Interest the first year will be $6,800 (10% × ($80,000 − $12,000)). So, amortization will be $5,200 ($12,000 − $6,800).
A ___asset represents a lessee’s right to use an underlying asset for the lease term.
right-of-use (ROU)
Which of the following statements is correct related to finance leases?
The ROU asset and the lease liability are initially measured at fair value.
The lessor is required to derecognize the underlying asset.
Interest expense related to the discount and amortization related to the ROU asset are combined into a single lease expense.
Most leases consist of property.
The lessor is required to derecognize the underlying asset.
The statements “Most leases consist of property” and “Interest expense related to the discount and amortization related to the right-of use (ROU) asset are combined into a single lease expense” are true for operating leases, not finance leases. The right-of-use (ROU) asset and lease liability are initially measured at the present value of the lease payments, not fair value.
Only the statement “The lessor is required to derecognize the underlying asset” is correct.
On January 1, Year 1, Frost Co. entered into a 2-year lease agreement with Ananz Co. to lease 10 new computers. The lease term begins on January 1, Year 1, and ends on December 31, Year 2. The lease agreement requires Frost to pay Ananz two annual lease payments of $8,000. The present value of the lease payments is $13,000. Which of the following circumstances would require Frost to classify and account for the arrangement as a finance lease?
Ownership of the computers remains with Ananz Co. throughout the lease term and after the lease ends.
Frost Co. does not have the option of purchasing the computers at the end of the lease term.
The fair value of the computers on January 1, Year 1, is $14,000.
The economic life of the computers is three years.
The fair value of the computers on January 1, Year 1, is $14,000.
this is corrent because the present value of the minimum lease payments ($13,000) is greater than 90% of the fair value of the leased asset.
For a lease to be treated as a finance lease, only one of the five criteria must be met (FASB ASC 842-10-25-2). One of the criteria is that “the present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments…equals or exceeds substantially all of the fair value of the underlying asset.” FASB ASC 842-10-55-2 uses the former 75% and 90% rules as benchmarks.
The present value of the lease payments ($13,000) exceeds 90% of the fair value of the computers (90% of $14,000 is $12,600).
The economic life of the computers is three years.is incorrect because the economic life of the computer must be greater than or equal to 75% of the economic life of the asset to qualify for capital lease treatment.
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31 of the current year:
- Sales price $ 400,000
- Carrying amount and FV $ 300k
- Monthly lease payment $ 3,250
- Present value of lease payments $ 36,900
- Estimated remaining life 25 years
- Lease term 1 year
- Implicit rate 12%
- What amount of gain on the sale should Mega report at December 31 of the current year?
$0
$100,000
$63,100
$36,900
$0
A sale-leaseback is generally treated as a single financing transaction in which any profit on the sale is deferred and amortized by the seller.
However, there is an exception to this general rule when either only a minor part of the remaining use of the leased asset is retained (case one) or when more than a minor part but less than substantially all of the remaining use of the leased asset is retained (case two).
- Case one occurs when the PV of the lease payments is 10% or less of the FV of the saleleaseback property.
- This problem is an example of case one, because the PV of the lease payments ($36,900) is less than 10% of the FV of the asset (10% � $400,000 = $40,000). Under these circumstances, the full gain ($400,000 � $300,000 = $100,000) is recognized, and none is deferred
- Case two occurs when the leaseback is more than minor but does not meet the criteria of a capital lease. ed.
A lease is classified as a finance lease because it contains a purchase option. Over what period of time should the lessee amortize the leased property?
The lease term or the economic life of the asset, whichever is shorter
The economic life of the asset, not to exceed 40 years
The economic life of the asset
The term of the lease
The economic life of the asset
With a finance lease resulting from a purchase option, the lessee amortizes the right-of-use (ROU) asset over the ROU asset’s useful life.
Which of the following statements is correct for the accounting of initial direct costs?
The lessor defers the cost and expenses over the life of the lease for both an operating lease and a sales-type lease with no selling profit.
The lessor defers the cost and expenses over the life of the lease, but only for a sales-type lease with selling profit.
The lessee records as an expense at the beginning of the lease.
The lessee defers the cost and expenses over the life of the lease for both an operating lease and a sales-type lease with selling profit.
he lessor defers the cost and expenses over the life of the lease for both an operating lease and a sales-type lease with no selling profit.
Lessees defer and then amortize initial direct costs for both operating and finance leases. Lessees do not use a sales-type classification, only operating and finance classifications. Lessors recognize initial direct costs at inception for sales-type leases with profit but defer initial direct costs for operating, direct financing, and sales-type without profit leases
__are those costs incurred by the lessor that (1) would not have incurred if the lease had not been entered into and (2) are the same for both the lessor and lessee (
The lessee should include initial direct costs in its initial ____of the right-of-use asset, and the initial direct costs are ___and amortized over the term of the lease on a straight-line basis for both finance leases and operating leases.
Initial direct costs (IDC)
deferred , measurement
The lessor accounting of any initial direct cost(s) varies based upon the type of lease.
Sales-type leases: The lessor should expense such costs at lease __if the lessor recognizes __at the inception of the lease. If there is no selling profit, the lessor should include these costs in determining the lease ___; thus, they would be deferred and recognized over the life of the lease in conjunction with the recognition of interest revenue.
Direct financing leases: The lessor should __initial direct costs and include these costs in determining the net ___in the lease; thus, they would be deferred and recognized over the life of the lease in conjunction with the recognition of interest revenue. Note: Deferral requires adjustment of the discount rate.
Operating leases: Such costs are __ and __over the term of the lease on a straight-line basis.
inception, selling profit, receivable
defer, investment
deferred and amortized
When a lessee has an operating lease and the payments required in the lease occur at the beginning of the lease period:
the balance in the right-of-use asset will be more than the balance in the lease liability account at the beginning of the second year of the lease.
the balance in the right-of-use asset account will be equal to the balance in the lease liability account at the beginning of the second year of the lease.
the balance in the right-of-use asset account will be less than the balance in the lease liability account at the beginning of the second year of the lease.
the balance in the right-of-use asset account can be either less than or greater than the balance in the lease liability account at the beginning of the second year of the lease, depending on how the lessee accounts for the lease.
the balance in the right-of-use asset will be more than the balance in the lease liability account at the beginning of the second year of the lease.
- When recording expense for an operating lease, the lessee records a single amount of expense that is made up of two parts, the interest on the lease obligation and the amortization of the right-of-use asset. In computing the components of lease expense at the end of the first year, interest expense is computed and amortization expense is the difference between the lease payment and the interest expense. This means that the amortization expense will be less than the lease payment.
- Since the amount of amortization expense is less than the payment, the carrying value of the right-of-use asset will be greater than the lease liability because at the beginning of the second year, the lease liability was reduced by the full lease payment when the first lease payment was made.
Both quantitative and qualitative disclosures are required for both the lessor and lessee. Which of the following is an incorrect matching of the information and party to the lease?
Lessor: contractual obligations for each of the five succeeding years
Lessee: information about risks associated with residual values
Lessor: gross investment and net investment in the lease
Lessee: operating lease costs
Lease obligations and lease costs are generally related to the lessee, while revenues and investments are generally related to the lessor.
Information about risks associated with residual values is reported by the lessor, not the lessee, as it affects the overall collectibility of the lease receivable.
Able Co. leased equipment to Baker under a noncancelable lease with a transfer of title. Will Able record depreciation expense on the leased asset and interest revenue related to the lease?
Depreciation expense: No; Interest revenue: Yes
Depreciation expense: Yes; Interest revenue: No
Depreciation expense: No; Interest revenue: No
Depreciation expense: Yes; Interest revenue: Yes
Depreciation expense: No; Interest revenue: Yes
A lease with transfer of title meets the criteria to be classified as a sales-type lease. The lessor (Able) should remove the asset from the books, record a receivable, and recognize interest revenue from the receivable.
Which of the following statements related to initial direct costs (IDC) is correct?
IDC include all internal costs associated with obtaining the lease.
IDC include items such as commissions and payments made to current tenants to obtain the lease.
IDC are included by the lessor in the measurement of an ROU asset.
IDC are expensed as incurred.
IDC include items such as commissions and payments made to current tenants to obtain the lease.
IDC are capitalized (not expensed) and include only those costs that entity would not have incurred if the lease had not been entered into (i.e., must be incremental costs, not internal, such as commissions and payments made to current tenants to obtain the lease). The lessee (not the lessor) includes IDC in the measurement of a right-of-use (ROU) asset.
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?
Profit on sale, $720,000; Interest revenue, $176,000
Profit on sale, $720,000; Interest revenue, $146,000
Profit on sale, $45,000; Interest revenue, $176,000
Profit on sale, $45,000; Interest revenue, $146,000
Profit on sale, $720,000; Interest revenue, $146,000
- 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 1 of the current year, Tell Co. leased equipment from Swill Co. under a 9-year finance lease. The equipment had a cost of $400,000 and an estimated useful life of 15 years. Semiannual lease payments of $44,000 are due every January 1 and July 1. The present value of lease payments at 12% was $505,000, which equals the sales price of the equipment. Using the straight-line method, what amount should Tell recognize as depreciation/amortization expense on the equipment in the current year?
$44,444
$26,667
$56,111
$33,667
$56,111
- Tell Co. must treat the lease as a finance lease because the present value of the lease payments exceeds 90% of the fair value (sales price) of the equipment.
- Tell’s cost equals the present value of $505,000.
- The question does not indicate or imply that Tell guarantees any residual value or that ownership transfers at the end of the 9-year lease.
- Therefore, the depreciable/amortizable cost of $505,000 must be charged to depreciation/amortization over the period of use, which is the lease term of 9 years. The depreciation/amortization expense for the current year (one full year’s depreciation/amortization) is $505,000 ÷ 9 years, or $56,111.
All of the following items are included in the initial measurement of lease liabilities except:
guaranteed residual value expected to be payable.
fixed payments, less any incentives receivable from the lessor.
exercise price of all purchase options.
variable lease payments that depend on an index or a rate.
exercise price of all purchase options.
The exercise price of a purchase option is included in the initial measurement of a lease liability only if the lessee has a significant economic incentive to exercise that option.
On January 1, Year 1, West Co. entered into a 10-year lease for a manufacturing plant. The annual lease payments are $100,000. In the notes to the December 31, Year 2, financial statements, what amounts of subsequent years’ lease payments should be disclosed?
Amount for required period, $100,000; Aggregate amount for period thereafter, $0
Amount for required period, $300,000; Aggregate amount for period thereafter, $500,000
Amount for required period, $500,000; Aggregate amount for period thereafter, $300,000
Amount for required period, $500,000; Aggregate amount for period thereafter, $0
Amount for required period, $500,000; Aggregate amount for period thereafter, $300,000
The lessee in a lease context must make disclosures as to future required payments under the lease. One must disclose the payments required under the lease for the next 5 years (here that is 5 × $100,000, or $500,000), as well as disclosing the total amounts to be paid thereafter or $300,000 (the 3 remaining years’ obligations at $100,000 a year).
Lease Disclosures
Lease disclosure requirements are quite extensive for both the lessor and lessee. Virtually all aspects of the lease ___must be disclosed.
The guiding objective is that lessees and lessors provide disclosures that enable users of financial statements to assess the __ __ and ___of cash flows arising from leases. Information disclosed is both qualitative and quantitative.
Qualitative
For both lessees and lessors, required qualitative disclosures include a general description of the__
agreement
amount, timing, and uncertainty
leasing arrangement
Lessees are required to disclose the following quantitative information:
- ___lease costs
- ___lease cost
- Short-term lease cost, excluding expenses relating to leases with a lease term of __month or less
- ___lease cost
- __income, disclosed on a gross basis, separate from the finance or operating lease expense
- Net gain or loss recognized from __transactions
- Weighted-average lease term of __leases and ___leases
- Weighted-average __rate
- A reconciliation of opening and closing balances of the ___ asset
- Contractual obligations for each of the ___succeeding fiscal years, plus a total for the remaining years
- A ___analysis of lease liabilities for each of the first five years after the balance sheet date and in total thereafter, including a reconciliation of the undiscounted cash flows to lease liabilities on the balance sheet
- Finance
- Operating
- one
- Variable
- Sublease
- sale/leaseback
- operating , finance
- discount
- ROU
- five
- maturity
- Winn Co. manufactures equipment that is sold or leased. On December 31, Year 1, Winn leased equipment to Bart for a 5-year period ending December 31, Year 6, at which date ownership of the leased asset will be transferred to Bart.
- Equal payments under the lease are $22,000 (including $2,000 executory costs) and are due on December 31 of each year.
- The first payment was made on December 31, Year 1. Collectibility of the remaining lease payments is reasonably assured, and Winn has no material cost uncertainties.
The normal sales price of the equipment is $77,000, and cost is $60,000. On December 31, Year 1, what amount of income should Winn realize from the lease transaction?
$17,000
$22,000
$23,000
$33,000
$17,000
- When accounting for a lease as a sales-type or direct financing lease for a lessor, one of the lease criteria must be met. In this situation, one criterion is a transfer of title at the end of the lease.
- Also, when accounting for one of these leases from the perspective of the lessor, one must further decide if the lease is sales-type or direct financing.
- Since the transfer of title criterion is met, this is considered a sales-type lease and there could 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 $17,000, the difference between the selling price and the cost of the equipment ($77,000 – $60,000).
The core principle of the lessee accounting model is that an entity should recognize assets and liabilities arising from leases with a lease term of more than:
6 months.
1 month.
1 year.
2 years.
1 year.
The core principle of the lessee accounting model is that an entity should recognize assets and liabilities arising from leases with a lease term of more than 1 year.
A company has an operating lease for its office space. The lease term is 120 months and requires monthly rent of $15,000. As an incentive for the company to enter into the lease, the lessor granted the first 8 months’ rent at no cost. What amount of monthly rent expense should be recognized over the life of the lease?
$16,072
$15,000
$14,000
$14,062
$14,000
Total lease expense should be ratably recognized over the life of the lease (on a straight-line basis). Total lease expense is $1,680,000 [(120 months − 8 free months) × $15,000]. Monthly lease expense is $14,000 ($1,680,000 ÷ 120-month lease term).
First year - first 8 months free (15,000 × 4 months) $ 60,000
Years 2-10 (12 months × $15,000 × 9 years) 1,620,000
Total rent on the lease $1,680,000
Divide by lease term of 120 months 120
Rent expense per month $ 14,000
Douglas Co. leased machinery with an economic useful life of 6 years. For tax purposes, the depreciable life is 7 years. The lease is for 5 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?
5 years
7 years
6 years
0
5 years
Both quantitative and qualitative disclosures are required for both the lessor and lessee. Which of the following is an incorrect matching of the information and the type of disclosure?
Qualitative: a general description of the leasing arrangement
Qualitative: a reconciliation of opening and closing right-of-use (ROU) asset balances
Quantitative: a maturity analysis of lease liabilities for each of the first five years after the balance sheet date
Quantitative: information about risks associated with residual values
Qualitative: a reconciliation of opening and closing right-of-use (ROU) asset balances
- Lease disclosure requirements are quite extensive for both the lessor and lessee.
- The guiding objective is that lessees and lessors provide disclosures that enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.
- Information disclosed is both qualitative and quantitative. Qualitative information describes the quality of something, while quantitative describes the quantity (i.e., amount) of something.
- A reconciliation is quantitative in nature, not qualitative.
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 finance lease?
The estimated useful life of the leased asset is 12 years.
The lease includes an option to purchase stock in the company.
The present value of the lease payments is $400,000.
The purchase option at the end of the lease is at fair market value.
The estimated useful life of the leased asset is 12 years.
- For a lease to be treated as a finance lease, only one of the five criteria must be met (FASB ASC 842-10-25-2).
- One of the criteria is: “The lease term is for the major part of the remaining economic life of the underlying asset.
- However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.” FASB ASC 842-10-55-2 uses the former 75% and 90% rules as benchmarks.
- The lease term of 10 years is more than 75% of the estimated useful life of the leased asset (12 years × 0.75 = 9 years).
On January 1, Year 7, Dance Digs, Inc. entered into a three-year operating lease. The payments were as follows: $15,300 for Year 7, $16,400 for Year 8, and $17,200 for Year 9. What is the correct amount of total lease expense for Year 8?
$17,200
$16,300
$15,300
$16,400
$16,300
In an operating lease, the lessee’s amortization expense is plugged so that total lease expense (interest plus amortization) is a straight-line amount. Therefore, lessees that hold operating leases with uneven payments (e.g., advance payment, scheduled rent increases, or scheduled rent decreases) must average the payments.
Total lease expense for Year 8 is $16,300 [($15,300 + $16,400 + $17,200) ÷ 3].
lessees that hold operating leases with uneven payments (e.g., advance payment, scheduled rent increases, or scheduled rent decreases) must ___the payments.
average
Wall Co. leased office premises to Fox, Inc., for a 5-year term beginning January 2, 20X1. Under the terms of the operating lease, rent for the first year is $8,000 and rent for Years 2 through 5 is $12,500 per annum. However, as an inducement to enter the lease, Wall granted Fox the first six months of the lease rent-free. In its December 31, 20X1, income statement, what amount should Wall report as rental income?
$8,000
$12,000
$11,600
$10,800
$10,800
In a sale/leaseback transaction, a gain resulting from the sale should be:
- deferred if the sale is at fair value.
- recognized immediately if the sale is at fair value.
Both I and II
I only
Neither I nor II
II only
II only
.
FASB ASC 842-40-30-2 provides that if the lease is not at fair value, the entity should adjust the sale price and record any gain as additional financing.
FASB ASC 842-40-55-24 provides an example where the gain is partially recognized and partially deferred as additional financing. Item I (deferred if the sale is at fair value) is incorrect as the deferral would only occur if the sale is not at fair value.
On January 1, 20X1, JCK Co. signed a contract for an 8-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 20X3, and should the revenue recognized in 20X3 be the same or smaller than the revenue recognized in 20X2?
20X3 interest revenue recognized; 20X3 amount recognized smaller than 20X2
20X3 rent revenue recognized; 20X3 amount recognized the same as 20X2
20X3 rent revenue recognized; 20X3 amount recognized smaller than 20X2
20X3 interest revenue recognized; 20X3 amount recognized the same as 20X2
20X3 interest revenue recognized; 20X3 amount recognized smaller than 20X2
if you look at the # of yrs they will lease makes it a capital lease.8 yrs of a 10 yr lease makes it 80% therefore a capital lease and if it’s a capital lease you recognize interest revenue. Since it qualifies as a capital lease, interest revenue is recorded. If this were an operating lease, then rent revenue would be recorded.
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.
On December 29, Year 1, Action Corp. signed a 7-year finance 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, Year 1. 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 finance lease liability in its December 31, Year 1, balance sheet?
$688,500
$841,500
$627,300
$780,300
$688,500
The finance lease obligation that a lessee recognizes on their books is based on the present value of the lease payments. The lease payments are the annual lease payments made at the beginning of each year of $153,000. The discount rate to get the present value of the payments is the rate implicit in the lease, unless that cannot be readily determined. In the case the lessee cannot determine the implicit rate, the lessee is required to use its incremental borrowing rate.
Here, the implicit rate in the lease is known to the lessee, which is 9%. Thus, the amount of the lease liability will be based on the present value factor for an annuity due of 7 years based on 9% (5.5) multiplied by the annual rental of $153,000:
- 5.5 × $153,000 = $841,500
However, since the first payment was just made, that amount must be lowered to get the remaining liability at the end of the year:
- $841,500 − $153,000 = $688,500
Factors an entity should assess in determining whether the lessee has a significant incentive to exercise an option to extend the lease include:
costs relating to the -__of the lease.
the amount of ___payments.
the amount of lease payments in any ___period.
termination
contingent
optional
Lease Term
The FASB defines a lease term as the ___period for which a lessee has the right to use an underlying asset, together with all of the following:
Periods covered by an option to __the lease if the lessee is reasonably certain (has a significant economic incentive) at the commencement date to __that option
Periods covered by an option to ___the lease if the lessee is reasonably certain (has a significant economic incentive at the commencement date) not to exercise that option
Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the __
noncancelable
extend , exercise
terminate
lessor
On June 1 of the current year, a company entered into a real estate lease agreement for a new building. The lease is an operating lease and is fully executed on that day. According to the terms of the lease, payments of $28,900 per month are scheduled to begin on October 1 of the current year and to continue each month thereafter for 56 months. The lease term spans five years. The company has a calendar year-end. What amount is the company’s lease expense for the current calendar year?
$188,813
$86,700
$161,838
$202,300
$188,813.
The commencement of a lease is the date of the lease agreement. Rental expense should be as of that date. When the lease payments begin later than the commencement date, the lease payments must be spread evenly over the longer period of time, which includes the months between the commencement date and the beginning of the lease payments.
- $28,900 × 56 months = $1,618,400
- $1,618,400 ÷ 60 months = $26,973.33
- $26,973.33 × 7 months (June through December) = $188,813
The lease term begins at the ___date and includes any ___periods provided to the lessee by the lessor. As a note of distinction, the lease inception date is the earlier of the date of the lease or the date of commitment by the parties for principal provisions of the lease. FASB ASC 842 uses the lease commencement date for the classification criteria.
commencement , rent-free
Koby Co. entered into a finance lease with a vendor for equipment on January 2 for seven years. The equipment has no guaranteed residual value. The lease required Koby to pay $500,000 annually on January 2, beginning with the current year. The present value of an annuity due factor for seven years was 5.35 at the commencement of the lease. What amount should Koby capitalize as leased equipment?
$2,675,000
$825,000
$3,500,000
$500,000
$2,675,000
- The lessee should capitalize the present value of the lease payments. The lease payments in this lease were the seven annual beginning-of-the-year payments of $500,000 each.
- There was not a purchase option, and the lessee did not guarantee any portion of residual value.
- 3The amount that should be capitalized is the $500,000 annuity payment times the present value of an annuity due for seven years (5.35), or $2,675,000.
$66,500.
This is a finance lease, and the lease liability for the lessee at the beginning of the lease is based on the present value of the lease payments, including the purchase at the end of the lease, discounted to their present value (at the beginning of the lease) based on the implicit interest rate specified in the lease itself.
Thus, the lease liability here is based on the $10,000 rental payments each year, plus the $10,000 purchase at the end of the 10th year. The present value of both of these items at the beginning of the lease, based on a 12% interest rate would be the $10,000 rent × 6.328 (the present value of an annuity due for 10 periods at 12%) = $63,280. Add this amount to the $10,000 × 0.322 (the present value of $1 at 12%, for 10 periods) = $3,220, and the two amounts add to $66,500.
Which is the correct way to compute periodic interest expense by a lessee for a finance lease?
Multiply the undiscounted cash flows over the term of the lease by the lease’s discount rate
Multiply the carrying amount of the lease liability by the lease’s discount rate
Multiply the straight-line lease expense by the lease’s discount rate
Multiply the periodic ROU asset amortization expense by the lease’s discount rate
Multiply the carrying amount of the lease liability by the lease’s discount rate
.Finance leases use the effective interest method, which calculates interest expense by multiplying the discount rate times the carrying value.
The initial measurement of the right-of-use asset includes all of the following except:
the amount of any fee related to extending the initial lease term.
any lease payment made at or before the lease commencement date, less any incentives received.
any initial direct costs incurred by the lessee.
the initial measurement of the lease liability.
the amount of any fee related to extending the initial lease term.
The right-of-use (ROU) asset is initially measured as the lease liability plus any lease payments made to the lessor at or before the commencement date, minus any lease incentives received, plus any initial direct costs incurred by the lessee.
The lessee should include initial direct costs in its initial measurement of the ROU asset and the initial direct costs are deferred and amortized over the term of the lease on a straight-line basis for both finance leases and operating leases. The ROU asset does not include fees to extend the initial lease term.
Which of the following statements about nonlease components is incorrect?
The lessee allocates the consideration to lease and nonlease components on a relative standalone price basis.
The lessee includes the nonlease component when computing the present value of the lease payments.
If the component cost represents a transfer of a good or service to the lessee, it is treated as a nonlease component.
Nonlease components are expensed by the lessee.
The lessee includes the nonlease component when computing the present value of the lease payments.
The other answer choices are correct:
- If the component cost represents a transfer of a good or service to the lessee, it is treated as a nonlease component.
- Nonlease components are expensed by the lessee.
- The lessee allocates the consideration to lease and nonlease components on a relative standalone price basis.
For a sales-type lease with selling profit, initial direct costs incurred by the lessor are:
capitalized as a contra asset and recognized over the term of the lease.
deferred (recorded as an asset) and expensed over the term of the lease.
expensed at the beginning of the lease.
expensed when the first lease payment is made.
expensed at the beginning of the lease
- Costs incurred by the lessor that are associated directly with originating a lease, that are essential to acquire that lease, and would not have been incurred had the lease agreement not occurred are called initial direct costs (IDC).
- The method of accounting for IDC depends on the nature of the lease.
- For a sales-type lease with selling profit, initial direct costs are expensed in the period of “sale”—that is, at the beginning of the lease.
- For an operating lease, direct financing lease, and sales-type lease without selling profit, initial direct costs are deferred (recorded as an asset) and expensed over the term of the lease. Initial direct costs are not contra assets.
Which of the following is not one of the criteria for classification as a finance lease?
The present value of the lease payments being a major part of the fair value
No alternative use for the asset
Transfer of ownership
Purchase option reasonably certain to exercise
The present value of the lease payments being a major part of the fair value
The present value of the lease payments being substantially all (not a major part) of the fair value is one of the five finance lease criteria.
The five FASB criteria for a finance lease are (1) transfer of ownership, (2) purchase option reasonably certain to exercise, (3) the lease term is the major part of the economic life of the asset, (4) the present value of the lease payments is substantially all of fair value, and (5) there is no alternative use for the asset.
Which of the following statements related to sale/leaseback transactions is incorrect?
Sale/leaseback transactions occur when a transferor sells an asset to a transferee and then the transferee leases that same asset back.
Sale/leaseback transactions generally involve fixed assets such as real estate.
If the transaction is not at fair value, the entity should adjust the selling price of the asset.
Sale/leaseback transactions may provide financing, accounting, or tax benefits.
Sale/leaseback transactions occur when a transferor sells an asset to a transferee and then the transferee leases that same asset back.
Sale/leaseback transactions occur when an entity (transferor) sells an asset to another entity (transferee) and then the transferor leases that same asset back from the transferee.
The other answer choices are correct statements:
If the sale/leaseback transaction is not at fair value, the entity should adjust the selling price of the asset.
Sale/leaseback transactions generally involve fixed assets such as real estate.
Sale/leaseback transactions may provide financing, accounting, or tax benefits.
On January 2, 20X1, Marx Co. as lessee signed a 5-year noncancelable equipment lease with annual payments of $200,000 beginning December 31, 20X1. Marx treated this transaction as a finance lease. The five lease payments have a present value of $758,000 at January 2, 20X1, based on interest of 10%. What amount should Marx report as interest expense for the year ended December 31, 20X1?
$0
$75,800
$48,400
$55,800
$75,800
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 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?
$3,000
$4,875
$6,000
$4,500
$4,875
Non-level lease payments must be expensed on a straight-line basis unless another systematic method is more representative.
- During January 20X1, Yana Co. incurred landscaping costs of $120,000 to improve leased property. The estimated useful life of the landscaping is 15 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.
On Yana’s December 31, 20X1, balance sheet, what should be the net carrying amount of landscaping costs?
$105,000
$110,000
$120,000
$0
$105,000
The landscaping costs represent a leasehold improvement. Leasehold improvements need to be amortized over the remaining term of the lease at the time of the improvement or the improvement’s own useful life, whichever is shorter.
Since there is no information indicating that the lease will be renewed beyond its original term, the most certain remaining lease term is eight years, which is shorter than the 15-year life of the landscaping. Therefore, the cost should be amortized over eight years.
Recall that carrying value is amortized cost (cost less accumulated amortization).
A company enters into a 3-year operating lease agreement effective January 1, Year 1. The amounts due to the lessor on the first day of each year are $25,000 in Year 1, $30,000 in Year 2, and $35,000 in Year 3. What amount, if any, is the related receivable to the lessor on the first day of Year 2?
$5,000
$65,000
$60,000
$0
$5,000
- On December 30, 20X1, Ames Co. leased equipment under a finance lease for 10 years. It contracted to pay $40,000 annual rent on December 31, 20X1, and on December 31 of each of the next nine years.
- The finance lease liability was recorded at $270,000 on December 30, 20X1, before the first payment.
- The equipment’s useful life is 12 years, and the interest rate implicit in the lease is 10%.
Ames uses the straight-line method to depreciate all equipment. In recording the December 31, 20X2, payment, by what amount should Ames reduce the finance lease liability?
$23,000\
$27,000
$17,000
$22,500
$17,000
$615,000
This lease qualifies as a finance lease because the lease term of 10 years exceeds 75% of the asset’s useful life of 12 years (10 > 0.75 × 12 = 9). When a lease is considered a finance lease, then the lessee capitalizes the lease property as a right-of-use asset and recognizes a lease obligation for the present value of the lease payments.
The lease payments are $100,000 a year at the end of each year, and their present value is $100,000 × 6.15 (present value of an ordinary annuity for 10 periods at 10%). Thus, the answer is $615,000:
$100,000 × 6.15 = $615,000
- On January 1, of the current year, Tree Co. enters into a 5-year lease agreement for production equipment. The lease requires Tree to pay $12,500 per year in lease payments. At the end of the 5-year lease term, Tree can purchase the equipment for $30,000.
- The fair value of the equipment is $75,000. The estimated useful life of the equipment is 10 years.
- The present value of the lease payments is $50,000.
- The present value of the purchase option is $20,000. Tree’s controller believes the purchase option price is sufficiently below the expected fair value of the equipment at the date the option becomes exercisable to reasonably assure its exercise.
- Tree would normally depreciate equipment of this type using the straight-line method.
What amount is the carrying value of the asset related to this lease at December 31 of the current year?
$63,000
$45,000
$40,000
$56,000
$63,000
On January 1, 20X1, Bay Co. acquired a land lease for a 21-year period with no option to renew. The lease required Bay to construct a building in lieu of rent. The building, completed on January 1, 20X2, at a cost of $840,000, will be depreciated using the straight-line method. At the end of the lease, the building’s estimated market value will be $420,000. What is the building’s carrying amount in Bay’s December 31, 20X2, balance sheet?
$800,000
$798,000
$820,000
$819,000
$798,000
Star Co. leases a building for its product showroom. The 10-year nonrenewable lease will expire on December 31, 20X6. In January 20X1, Star redecorated its showroom and made leasehold improvements of $48,000.
The estimated useful life of the improvements is 8 years. Star uses the straight-line method of amortization. What amount of leasehold improvements (net of amortization) should Star report in its June 30, 20X1, balance sheet?
$45,600
$44,000
$45,000
$43,200
$44,000
$461,456
The value of the machine from the lease is the present value of the lease payments (using the annuity due factor) and the present value of the guaranteed residual value, over the five-year lease term, as follows: ($100,000 × 4.4651) + ($20,000 × 0.7473) = $461,456.
A finance lease agreement requires quarterly lease payments of $5,376 over a 10-year lease term, with the first payment on July 1, the beginning of the lease. The annual interest rate is 8%. Both the present value of the lease payments and the cost of the asset to the lessor are $150,000. What would be the amount of interest expense the lessee would record for the quarterly payment on October 1?
$2,892
$11,570
$0
$3,000
$2,892
Lease Liability = $76,840; Interest Expense = $7,807
The original liability can be calculated in one of two ways: (1) present value of an annuity due for 4 periods at 7% or (2) present value of an ordinary annuity for 3 periods plus the first payment. The answer is exactly the same.
- Present Value, Annuity Due (PVAD): $42,500 at 7% for 4 periods = $42,500 × 3.62432 = $154,033
- Present Value, Ordinary Annuity (PVOA): $42,500 at 7% for 4 periods = $42,500 × 2.62432 = $111,533 + $42,500 = $154,033
One payment is made on day one, reducing the lease liability before any interest ($154,033 – $42,500 = $111,533). Interest on the liability for the year would be $7,807 ($111,533 × .07), recorded with another payment made on the last day of the year, so the liability would be $76,840 with rounding ($111,533 – $34,693 ($42,500 – $7,807)).
