Section 3F - Leases Flashcards

1
Q

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

A

$8,500

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2
Q

The lessee is required to recognize a lease liability equal to the ___of the lease payments. Lease payments consist of the following:

  1. Fixed payments T/F
  2. Variable lease payments that depend on an __ or a __
  3. The exercise price of an ___to purchase the underlying asset if the lessee is reasonably certain to exercise the option
  4. Payments for penalties for ___the lease,
  5. __paid by the lessee to the owners of a special-purpose entity for structuring the transactions
  6. For lessees only, amounts probable of being owed by the lessee under residual value __
A

present value

true

index or a rate

option

terminating

Fees

guarantees

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3
Q

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.

A

measurement

at or before , incentives

direct costs

finance , certain, amortize

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4
Q

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

A

$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.

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5
Q

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

A

fixed

true

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6
Q

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.

A

leaseback, same manner

finance or sales-type

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7
Q

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

A

true

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8
Q

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:

  1. Present value of an annuity due of $1 at 10% for 6 periods: 4.791
  2. 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.

A

$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.

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9
Q

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.

A

Title

purchase option

remaining economic life

equals or exceeds

specialized , alternative use

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10
Q

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.

A

investment, carrying amount

interest , effective

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11
Q

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

A

$243,150

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12
Q

Both lessees and lessors discount lease payments at the ___date using the rate implicit 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:

  1. the fair value of the underlying asset minus any related investment __retained and expected to be realized by the lessor, and
  2. 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.

A

lease commencement

tax credit

direct costs

whole

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13
Q

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.

A

incremental borrowing

incremental borrowing, collateralized

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14
Q

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.

A

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.

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15
Q

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.

A

$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).

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16
Q

A ___asset represents a lessee’s right to use an underlying asset for the lease term.

A

right-of-use (ROU)

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17
Q

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.

A

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.

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18
Q

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.

A

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.

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19
Q

The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31 of the current year:

  1. Sales price $ 400,000
  2. Carrying amount and FV $ 300k
  3. Monthly lease payment $ 3,250
  4. Present value of lease payments $ 36,900
  5. Estimated remaining life 25 years
  6. Lease term 1 year
  7. Implicit rate 12%
  8. What amount of gain on the sale should Mega report at December 31 of the current year?

$0

$100,000

$63,100

$36,900

A

$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.
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20
Q

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

A

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.

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21
Q

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.

A

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

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22
Q

__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.

A

Initial direct costs (IDC)

deferred , measurement

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23
Q

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.

A

inception, selling profit, receivable

defer, investment

deferred and amortized

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24
Q

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.

A

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.
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25
Q

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

A

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.

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26
Q

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

A

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.

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27
Q

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.

A

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.

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28
Q

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

A

Profit on sale, $720,000; Interest revenue, $146,000

  1. 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).
  2. 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.
  3. 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).
  4. 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).
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29
Q

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

A

$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.
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30
Q

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.

A

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.

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31
Q

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

A

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).

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32
Q

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__

A

agreement

amount, timing, and uncertainty

leasing arrangement

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33
Q

Lessees are required to disclose the following quantitative information:

  1. ___lease costs
  2. ___lease cost
  3. Short-term lease cost, excluding expenses relating to leases with a lease term of __month or less
  4. ___lease cost
  5. __income, disclosed on a gross basis, separate from the finance or operating lease expense
  6. Net gain or loss recognized from __transactions
  7. Weighted-average lease term of __leases and ___leases
  8. Weighted-average __rate
  9. A reconciliation of opening and closing balances of the ___ asset
  10. Contractual obligations for each of the ___succeeding fiscal years, plus a total for the remaining years
  11. 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
A
  1. Finance
  2. Operating
  3. one
  4. Variable
  5. Sublease
  6. sale/leaseback
  7. operating , finance
  8. discount
  9. ROU
  10. five
  11. maturity
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34
Q
  • 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

A

$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).

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35
Q

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.

A

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.

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36
Q

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

A

$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

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37
Q

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

A

5 years

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38
Q

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

A

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.
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39
Q

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.

A

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).
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40
Q

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

A

$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].

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41
Q

lessees that hold operating leases with uneven payments (e.g., advance payment, scheduled rent increases, or scheduled rent decreases) must ___the payments.

A

average

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42
Q

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

A

$10,800

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43
Q

In a sale/leaseback transaction, a gain resulting from the sale should be:

  1. deferred if the sale is at fair value.
  2. recognized immediately if the sale is at fair value.

Both I and II

I only

Neither I nor II

II only

A

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.

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44
Q

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

A

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.

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45
Q

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:

  1. 9% for 7 years: 5.5
  2. 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

A

$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
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46
Q

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.

A

termination

contingent

optional

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47
Q

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 __

A

noncancelable

extend , exercise

terminate

lessor

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48
Q

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

A

$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
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49
Q

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.

A

commencement , rent-free

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50
Q

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

A

$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.
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51
Q
A

$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.

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52
Q

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

A

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.

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53
Q

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.

A

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.

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54
Q

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.

A

The lessee includes the nonlease component when computing the present value of the lease payments.

The other answer choices are correct:

  1. If the component cost represents a transfer of a good or service to the lessee, it is treated as a nonlease component.
  2. Nonlease components are expensed by the lessee.
  3. The lessee allocates the consideration to lease and nonlease components on a relative standalone price basis.
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55
Q

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.

A

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.
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56
Q

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

A

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.

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57
Q

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.

A

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.

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58
Q

On December 31, Year 6, Bradley Corp. sold a piece of land with a carrying cost of $1 million to Kravis Inc. for $2 million and simultaneously leased it back for 10 years with annual payments of $120,000 payable at the end of each year using a 5% discount rate. The lease is appropriately recorded as a sale and leaseback transaction by both Bradley and Kravis. The market rates for the lease of the land are $90,000, payable annually at the end of each year. What amount would Bradley recognize as a financial liability at the commencement of the lease? (PV for n=10, i=5% is 7.72173.)

$0

$768,348

$231,652

$694,956

A

$231,652

After the commencement date, both Bradley and Kravis account for the lease by treating $90,000 of the annual $120,000 payment as lease payments.

The remaining $30,000 of annual payments are discounted over 10 periods at 5% and are accounted for as payments made to settle the financial liability of $231,652 recognized by Bradley and payments received to settle the financial asset of $231,652 recognized by Kravis ($30,000 × 7.72173).

59
Q

For operating leases, which of the following statements is incorrect?

An operating lease is considered a “non-debt” liability.

The lessor records a lease receivable.

An operating lease does not meet any of the criteria for a finance lease.

Rights and responsibilities of ownership are retained by the lessor.

A

The lessor records a lease receivable.

The lessor does not record a receivable; rather, the lessor treats operating leases as a rental arrangement and records rent revenue on a straight-line basis over the lease term. The lessor does not derecognize the leased asset.

Operating leases are considered “non-debt” liabilities to separate them from traditional liabilities, and are therefore excluded from debt ratios. Operating leases cannot meet any of the finance lease criteria, and the rights and responsibilities do not transfer to the lessee but are retained by the lessor.

60
Q

Restaurant Equipment, Inc., leased nonspecialized equipment, with an original cost of $5 million and a remaining estimated useful life of 10 years, to Rocky Bottom Cafe for a 5-year period, at which time possession of the equipment will revert back to Restaurant Equipment, Inc.

The equipment normally sold for $6.1 million. The present value of the lease payments for both the lessor and lessee is $5.3 million.

The lessee does not strictly adhere to the suggested FASB criteria guidelines. The first payment was made at the beginning of the lease. How should Rocky Bottom Cafe classify this lease?

Sales-type lease with selling profit

Finance lease

Sales-type lease without selling profit

Operating lease

A

Operating lease

  • The lease is an operating lease to Rocky Bottom Cafe because the present value of the lease payments is not “substantially all” of the fair value of the asset ($5.3 million ÷ $6.1 million = 87%).
  • While FASB ASC 842 no longer applies a “bright line” test to the classification of leases, 90% of fair value is generally considered the cutoff in determining “substantially all” of the fair value.
  • Absent information that Rocky Bottom Cafe applies a different standard in its accounting policies, this would not represent substantially all of the fair value. None of the five classification criteria for finance leases are met.
61
Q

On July 1, 20X0, Gee, Inc., leased a delivery truck from Marr Corp. under a 3-year operating lease. Total rent for the term of the lease will be $36,000, payable as follows:

  1. 12 months at $ 500 = $ 6,000
  2. 12 months at $ 750 = 9,000
  3. 12 months at $1,750 = 21,000

All payments were made when due. In Marr’s June 30, 20X2, balance sheet, the accrued rent receivable should be reported as:

$9,000.

$21,000.

$12,000.

$0

A

$9,000.

This problem tests the rule that straight-line recognition should be used to record the rent revenue, regardless of the payment schedule.

At $1,000 per month (straight-line), total revenue recognized by the end of the second year should be $24,000.

Since cash was actually received at that point in the amount of $15,000 ($9,000 + $6,000), a receivable of $9,000 remains in the rent receivable account for the difference ($24,000 − $15,000).

62
Q

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

A

$75,800

63
Q

Spring Corp. entered into a 5-year lease agreement with Fall Corp. Spring, the lessee, paid an additional $5,000 nonrefundable lease bonus to Fall upon signing the operating lease agreement. When would Spring recognize in expense the nonrefundable lease bonus paid by Fall?

At the expiration of the lease

When received

Over the life of the lease

At the commencement of the lease

A

Over the life of the lease

Fees associated with acquiring a contract—including a lease contract—are considered initial direct costs under and are capitalized in the right-of-use asset and amortized over the life of the lease.

64
Q

Farm Co. leased equipment to Union Co. on July 1, 20X1, and properly recorded the sales-type lease at $135,000, the present value of the lease payments discounted at 10%. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, 20X1. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its 20X1 income statement?

$5,500

$6,750

$0

$5,750

A

$5,750

Initial amount of lease $135,000
Less first payment 20,000
Lease amount applicable to last half of 20X1 $115k
Times interest rate (10% x 6/12 year) x .05
Interest revenue for 20X1 $ 5,750

65
Q

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

The lease payments less initial direct costs

The lease payments less residual value

The lease payments plus any executory costs

The lease payments plus residual value

A

The lease payments plus residual value

The lessor shall measure the lease receivable in a direct financing lease initially as the sum of the following amounts:

  • The lease payments
  • The unguaranteed residual value accruing to the benefit of the lessor
  • The guaranteed residual value by the lessee or third party
66
Q

The lessor shall measure the lease receivable in a direct financing lease initially as the sum of the following amounts:

  1. The lease___
  2. The ___residual value accruing to the benefit of the lessor
  3. The guaranteed ___ value by the lessee or third party
A

payments

unguaranteed

residual value

67
Q
  • On January 2, 20X1, Nori Mining Co. (lessee) entered into a 5-year lease for drilling equipment.
  • Nori accounted for the acquisition as a finance lease for $240,000, which includes a $10,000 purchase option. At the end of the lease, Nori is reasonably certain to exercise the 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, 20X1, what amount should Nori recognize as depreciation expense on the leased asset?

$30,000

$46,000

$27,500

$48,000

A

27,500

FASB ASC 842-20-35-8 states, “A lessee shall amortize the right-of-use asset from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term.

However, if the lease transfers ownership of the underlying asset to the lessee or the lessee is reasonably certain to exercise an option to purchase the underlying asset, the lessee shall amortize the right-of-use asset to the end of the useful life of the underlying asset.” Thus, Nori recognizes depreciation expenses as follows:

Depreciation
expense for 20X1 = (Cost - Salvage value) / Useful life
= ($240,000 - $20,000) / 8 years
= $220,000 / 8
= $27,500

68
Q

Glade Co. leases computer equipment to customers under sales-type leases. The equipment has no residual value at the end of the lease and the leases do not contain 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 five years is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease?

$75,000

$129,360

$51,600

$139,450

A

$51,600
Annual lease payment = Fair value of equipment / Present value factor
= $323,400 / 4.312
= $75,000

Total lease amount collected = Annual lease payment x 5 years
= $75,000 x 5
= $375,000
Interest revenue = Lease amount collected - Fair value of equipment earned

= $375,000 - $323,400
= $51,600

69
Q

Which of the following is a characteristic of a finance lease?

The future obligation does not appear in the balance sheet of the lessee.

The lease term is substantially less than the estimated economic life of the leased property.

The lease contains a purchase option that is reasonably certain to be exercised.

The present value of the lease payments at the beginning of the lease term is 75% or more of the fair value of the property at the commencement of the lease.

A

The lease contains a purchase option that is reasonably certain to be exercised.

  1. Title (ownership) transfers to the lessee by the end of the lease term.
  2. The lease contains a purchase option that the lessee is reasonably certain to exercise.
  3. The lease term is for the major part of the remaining economic life of the underlying asset. This criterion shall not be used if the lease commencement date is near the end of the asset’s economic life.
  4. The present value of the sum of the lease payments and any lessee guaranteed residual value not already in the lease payments equals or exceeds substantially all of the fair value of the underlying asset. “Substantially all” is considered 90% or more of the present value.
  5. The underlying asset is specialized and is not expected to have an alternative use to the lessor at the end of the lease term.
70
Q

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

A

$4,875

Non-level lease payments must be expensed on a straight-line basis unless another systematic method is more representative.

71
Q

Restaurant Equipment, Inc., leased nonspecialized equipment, with an original cost of $5 million and a remaining estimated useful life of 10 years, to Rocky Bottom Cafe for a 5-year period, at which time possession of the equipment will revert back to Restaurant Equipment, Inc. The equipment normally sold for $6.1 million. The present value of the lease payments for both the lessor and lessee is $5.3 million. The first payment was made at the beginning of the lease. How should Restaurant Equipment, Inc., classify this lease?

Operating lease

Operating lease or sales-type lease with selling profit

Sales-type lease without selling profit

Sales-type lease with selling profit

A

Operating lease

  • Restaurant Equipment, Inc., would classify the lease as an operating lease. Although bright lines have been removed, FASB ASC 842-10-55-2 establishes that the former rules (75% rule and 90% rule) would be a reasonable approach to use as a benchmark.
  • The lease is for 50% (5 years/10 years) of the economic life. The present value of the lease payments is 87% ($5.3 million ÷ $6.1 million = 87%) of the fair value of the underlying asset, representing less than “substantially all” of the fair value of the asset.
  • Without further information, this percentage would not result in the lease being classified as a sales-type lease with selling profit.
  • Therefore, Restaurant Equipment, Inc., should classify this as an operating lease if its accounting policy adheres to the 90% rule.
72
Q

Steam Co. acquired equipment under a finance lease for six years. Lease payments were $60,000 payable annually at year-end. The interest rate was 5% with an annuity factor for six years of 5.0757. The present value of the payments was equal to the fair market value of the equipment. What amount should Steam report as interest expense at the end of the first year of the lease?

$18,000

$15,227

$0

$3,000

A

$15,227

The initial obligation would be capitalized at $60,000 × 5.0757 = $304,542.

Initial obligation $304,542
Interest rate (5%) x .05
Interest expense $ 15,227

73
Q

Under FASB Topic 842 lease guidance, which of the following is correct regarding initial direct costs?

Only incremental costs will qualify as initial direct costs.

Lessees and lessors will apply different definitions of initial direct costs.

Lessees and lessors cannot have different initial direct costs for the same lease.

Initial direct costs are expensed for operating leases.

A

Only incremental costs will qualify as initial direct costs.

Only incremental costs qualify as initial direct costs subject to capitalization in both lessor and lessee accounting. The same definition is used by both lessors and lessees: these costs are (1) those that the entity would not have incurred if the lease had not been entered into and (2) are the same for both the lessor and lessee.

Although the definition of what qualifies as an initial direct cost is the same for the lessee and lessor, the lessee and lessor may have different costs associated with the lease. Initial direct costs are capitalized and amortized over the life of the lease.

74
Q

Only incremental costs qualify as initial direct costs subject to capitalization in both lessor and lessee accounting. The same definition is used by both lessors and lessees: these costs are

(1) those that the entity would not have __if the lease had not been entered into and
(2) are the same for both the ___ and __.

A

incurred

lessor and lessee

75
Q
  • 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

A

$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).

76
Q

Rig Co. sold its factory at a gain, and simultaneously leased it back for 10 years. The factory’s remaining economic life is 20 years. The sale was at fair value. The lease was reported as an operating lease. At the time of sale, Rig should report the gain as:

a deferred gain

a gain appearing on the income statement.

additional financing.

an item of other comprehensive income.

A

a gain appearing on the income statement.

Per the question information, this would qualify as a sale/leaseback transaction. If the sale/leaseback transaction was at fair value, the gain can be recognized. If it was below fair value, the gain should be deferred and treated as additional financing.

77
Q
  • Cott, Inc., prepared an interest amortization table for a 5-year lease payable with a purchase option of $2,000 that is reasonably certain to be exercised, exercisable at the end of the lease.
  • At the end of the five years, the balance in the leases payable column of the spreadsheet was zero.
  • Cott has asked Grant, CPA, to review the spreadsheet to determine the error.

Only one error was made on the spreadsheet. Which of the following statements represents the best explanation for this error?

  1. Cott subtracted the annual interest amount form the lease payable balance instead of adding it.
  2. The present value of the purchase option was subtracted from the present value of the annual payments
  3. Cott discounted the annual payments as an ordinary annuity, when the payments actually occurred at the beginning of each period.
  4. The beginning present value of the lease did not include the present value of the purchase option.
A

The beginning present value of the lease did not include the present value of the purchase option.

  • The liability under a finance lease obligation should be equal to the discounted present value of the lease payments, which includes a purchase option reasonably certain to be exercised.
  • If the calculated liability includes only the discounted present value of the periodic payments to be made over the 5-year lease term, the liability will be shown as paid in full with the last periodic payment.
  • Therefore it appears Cott did not include the amount of its purchase option in the lease payments when calculating its lease liability.
78
Q

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?

The shipping company will not derecognize the asset in the current year.

The shipping company will recognize the total profit on the sale of the boat in the current year.

The shipping company will not recognize depreciation expense for the boat in the current year.

The boat will not be classified in property, plant, and equipment of the shipping company.

A

The shipping company will not derecognize the asset in the current year.

  • 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 title will transfer back to the shipping company, this does not qualify for sale/leaseback treatment. The shipping company will not derecognize the asset and will recognize the consideration received as a financial liability.
79
Q

Which of the following statements about leases is correct?

  1. For lessee operating leases, the expense recognized would be the straight-line amount of the future lease payments and deferred initial direct costs.
  2. For lessee finance leases, recognized interest expense would be the same for every year of the lease.
  3. For lessee operating leases, lease expense is broken into two parts for presentation purposes: amortization of the ROU (right-of-use) asset and interest expense.
  4. For lessee finance leases, lease expense is presented as one amount, representing the straight-line expense of lease payments and the deferral of initial direct costs.
A

For lessee operating leases, the expense recognized would be the straight-line amount of the future lease payments and deferred initial direct costs.

  • .Finance leases use the effective interest method, not the straight-line method.
  • This results in yearly interest expense differences. For operating leases, the yearly expense remains constant (straight-line) since it combines the lease liability and amortization into one yearly amount.
  • Lessee operating leases show one constant cost/expense that combines the lease liability unwinding and asset amortization versus finance leases that separate the lease liability unwinding and asset amortization.
80
Q

FASB ASC 360-10-15-4 requires testing for impairment loss for certain long-lived assets. Which of the following types of leases is tested for impairment?

Both finance leases of lessees and long-lived assets of lessors subject to operating leases

Neither finance leases of lessees nor long-lived assets of lessors subject to operating leases

Long-lived assets of lessors subject to operating leases

Finance leases of lessees

A

Both finance leases of lessees and long-lived assets of lessors subject to operating leases

FASB ASC 360-10-15-4 lists the following types of leases that are tested for impairment:

  1. Right-of-use assets of lessees
  2. Long-lived assets of lessors subject to operating leases
  3. Proved oil and gas properties that are being accounted for using the successful-efforts method of accounting
  4. Long-term prepaid assets
81
Q

FASB ASC 360-10-15-4 lists the following types of leases that are tested for impairment:

___assets of lessees

Long-lived assets of lessors subject to ___leases

Proved __ and ___properties that are being accounted for using the successful-efforts method of accounting

Long-term ___assets

A

Right-of-use

operating

oil and gas

prepaid

82
Q

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

A

$5,000

83
Q

The right-of-use (ROU) asset is considered to be a separate lease component if:

  1. the underlying asset is not highly dependent on, or highly interrelated with, other underlying assets in the contract.
  2. the lessee can benefit from use of the asset either on its own or together with other, readily available, resources.

II only

I only

Neither I nor II

Both I and II

A

Both I and II

.

Both of the listed criteria must be met in order for the ROU asset to be considered a separate lease component:

  • The underlying asset is not highly dependent on, or highly interrelated with, other underlying assets in the contract.
  • The lessee can benefit from use of the asset either on its own or together with other, readily available, resources.
84
Q

A lessee uses all of the following factors to determine if a lease is a finance or operating lease, except:

transfer of the asset title at the end of the lease.

lease payments represent more than half (>50%) of the asset fair value.

the lease term is for a major portion of the asset’s life.

inclusion of a purchase option that the lessee is reasonably certain to exercise.

A

lease payments represent more than half (>50%) of the asset fair value.

Lease payments must represent substantially all of the asset fair value, not more than half (>50%).

The other answer choices are correct. A lessee uses the following factors to determine if a lease is a finance or operating lease:

  1. Inclusion of a purchase option that the lessee is reasonably certain to exercise
  2. Transfer of the asset title at the end of the lease
  3. The lease term is for a major portion of the asset’s life.
85
Q

A lessee uses the following factors to determine if a lease is a finance or operating lease:

  1. Inclusion of a ____that the lessee is reasonably certain to exercise
  2. Transfer of the asset ___at the end of the lease
  3. The lease term is for a major portion of the___
A

purchase option

title

assets life

86
Q

Which of the following statements about leases is incorrect?

After determining that a contract contains a lease, an entity must identify each separate lease component within the contract.

The guidance in FASB Topic 842 applies to leases on intangible assets, inventory, and assets under construction.

Under FASB Topic 842, there is no “low value” exemption.

The customer must control the identified asset in order for the transaction to be considered a lease.

A

The guidance in FASB Topic 842 applies to leases on intangible assets, inventory, and assets under construction.

.

FASB Topic 842 does not apply to (1) leases of intangible assets, inventory, and assets under construction; (2) leases to explore for or use minerals, oil, natural gas, and similar nonregenerative resources; or (3) leases of biological assets, including timber.

The customer or the lessor can control the asset. A low-value exemption, along with a short-term exemption, is contained in FASB ASC 842.

87
Q

On March 1, 20X1, Ila Co. made a significant decision to not exercise the purchase option at the end of the lease term. requiring modification of the terms of a 4-year lease of equipment. Ila had leased the equipment on January 1, 20X1, and properly recorded it as a finance lease due to the option purchase. Under the modified provisions, the lease would have been classified as:

an operating lease.

a leverage lease.

a finance lease.

a sales-type lease.

A

an operating lease.

FASB ASC 842-10-25-9 requires that a modified lease not accounted for as a separate contract to be reassessed as of the modification date and be accounted for in accordance to FASB ASC 842-10-25-10 through 25-14. The lease modification changed the lease classification from a finance lease to an operating lease effective March 1, 20X1.

88
Q

Leasing is an important activity:

only for not-for-profit entities.

for many organizations.

only for private companies.

only for public entities.

A

for many organizations.

Leasing provides access to assets and financing. It reduces risk exposure related to owning an asset. Almost all entities enter into some form of lease (e.g., rental of office space).

89
Q

Which of the following represents a difference in lessor accounting for sales-type versus direct financing leases?

Direct financing leases derecognize the leased asset; sales-type leases do not derecognize the leased asset.

In both types, profit or loss on sale is deferred. In a sales-type lease it is recognized over the term of the lease; in a direct financing lease it is recognized at the end of the lease.

Selling profit or loss is recognized immediately in a sales-type lease while it is deferred in a direct financing lease.

Sales-type leases derecognize the leased asset; direct financing leases do not derecognize the leased asset.

A

Selling profit or loss is recognized immediately in a sales-type lease while it is deferred in a direct financing lease.

  • Both sales-type leases and direct financing leases require the lessor at commencement to derecognize the leased asset and recognize the net investment in the lease.
  • Sales-type leases recognize a selling profit at commencement whereas selling profits are deferred in direct financing leases.
90
Q

For the discount rate used in leases, which of the following statements is incorrect?

The discount rate is the implicit rate in the lease.

The discount rate affects almost every amount calculated by the lessor and lessee.

The discount rate is the rate that the lessee would expect to pay a bank if funds were borrowed to buy (rather than lease) the asset.

The discount rate is considered the “desired” rate of return for the lessor.

A

The discount rate is the rate that the lessee would expect to pay a bank if funds were borrowed to buy (rather than lease) the asset.

  • The rate that the lessee would expect to pay a bank if funds were borrowed to buy (rather than lease) the asset is the lessee’s incremental borrowing rate, not the discount rate.
  • The discount rate is the rate implicit in the lease and is the rate that the lessor “desires” to achieve a certain lease payment. If the lessee does not know the implicit rate, they are allowed to use the incremental rate instead.
91
Q

A lease is recorded as a sales-type lease by the lessor. The interest income in net investment in the lease should be:

amortized over the period of the lease as interest revenue using the effective interest method.

recognized in full as interest revenue at the lease’s commencement.

recognized in full as manufacturer’s or dealer’s profit at the lease’s commencement.

amortized over the period of the lease as interest revenue using the straight-line method.

A

amortized over the period of the lease as interest revenue using the effective interest method

  • Some of the revenue recognized by a lessor on a sales-type lease is financing revenue, interest revenue included within the rent payments.
  • The lease transaction is treated as a purchase on credit, and part of the payments is treated as an interest element to the transaction, using the interest rate implicit in the lease and the implied principal financed by the rental payments using an effective interest rate (the implicit rate)..
92
Q

On January 5, 20X9, Mandu Inc. signs a 10-year equipment lease; the equipment has an economic life of 12 years. Lease payments are $9,000 per year, discounted at 5% to a present value of $69,500. The fair value of the leased asset at commencement is $75,000. From the lessee’s perspective this lease should be classified as a(n):

sales-type lease.

finance lease.

installment lease.

operating lease.

A

finance lease.

The lessee determines that the lease is a finance lease because (1) the lease term is for a significant portion of the asset’s life (83.3%) and (2) the present value of the lease payments represent a significant portion of the asset’s fair value (92.7%).

93
Q

On December 1, 20X1, Clark Co. leased office space under an operating lease for five years at a monthly rental of $60,000. On the same date, Clark paid the lessor the following amounts:

First month’s ren $ 60,000
Last month’s rent 60,000
Security deposit (refundable at lease expiration) 80,000
Installation of new walls and offices 360,000

What should be Clark’s 20X1 expense relating to utilization of the office space?

$120,000

$140,000

$66,000

$60,000

A

$66,000

The cost of the installation of walls and offices should be capitalized as a leasehold improvement and amortized over the lease term.

Clark Co.’s December 20X1 office utilization expense consists of:
Monthly rent $60,000
Amortization of walls and offices
($360,000 / 60 months = $6,000/month) 6,000
Total $66,000

Note: The last month’s rent is capitalized as prepaid rent and expensed the last month of the lease term. The refundable security deposit is an asset.

94
Q

Which of the following statements related to the residual value guarantee is incorrect?

The residual value guarantee may be provided by the lessee or a third party.

Only the amount probable of being paid is included in determining the lease liability and the ROU asset.

The residual value guarantee generally results in operating classification by lessees.

The residual value guarantee is made to the lessor by the lessee that the value of an underlying asset returned at the end of the lease will be at least a specified amount.

A

The residual value guarantee generally results in operating classification by lessees.

Residual value guarantees generally result in finance classification by lessees.

95
Q

The ____guarantee may be provided by the lessee or a third party.

Only the amount probable of being paid is included in determining the ___liability and the __.

The residual value guarantee is made to the lessor by the lessee that the value of an underlying asset returned at the end of the lease will be at least a ___amount.

A

residual value

lease , ROU

specified

96
Q
  • Howe Co. leased equipment to Kew Corp. on January 2, 20X1, for an 8-year period expiring December 31, 20X8. Equal payments under the lease are $600,000 and are due on January 2 of each year.
  • The first payment was made on January 2, 20X1.
  • the list selling price of the equipment is $3,520,000 and its carrying cost on Howe’s books is $2,800,000. The lease is appropriately accounted for as a sales-type lease.
  • The present value of the lease payments at an imputed interest rate of 12% (Howe’s incremental borrowing rate) is $3,300,000.

What amount of profit on the sale should Howe report for the year ended December 31, 20X1?

$720,000

$90,000

$500,000

$0

A

$500,000

Sales-type leases give rise to profit to the lessor usually defined as the difference between the sales price and the carrying value of the asset.

Present value of lease payments (i.e. sales price) $3,300,000
Less carrying value of leased property 2,800,000
Income to be reported for year ended December 31, 20X1 $ 500,000

97
Q

When should a lessor recognize in income a nonrefundable lease bonus paid by a lessee on signing an operating lease?

At the commencement of the lease

Over the life of the lease

When received

At the expiration of the lease

A

Over the life of the lease

FASB ASC 842-30-25-11 stipulates that the income shall be recognized on a straight-line basis unless another systematic and rational basis is more clearly evident.

Since the bonus represents a deviation from a straight-line pattern of lease payments, it should be recognized in income in straight-line fashion over the life of the lease.

98
Q
  • Lease M does not contain a purchase option, but the lease term is equal to 90% of the estimated economic life of the leased property.
  • Lease P does not transfer ownership of the property to the lessee at the end of the lease term, but the lease term is equal to 75% of the estimated economic life of the leased property.

How should the lessee classify these leases?

Lease M as an operating lease and Lease P as a finance lease

Both Lease M and Lease P as finance leases

Both Lease M and Lease P as operating leases

Lease M as a finance lease and Lease P as an operating lease

A

Both Lease M and Lease P as finance leases

Lease M is a finance lease because the lease term is greater than or equal to 75% of the economic life of the property. Lease P is also a finance lease for the same reason.

99
Q

Mad Melvin Inc. signed an operating lease with Handy Dandy Company on March 1, Year 5. The lease agreement is an operating lease requires five annual payments of $20,000 by Mad Melvin beginning on March 1, Year 5, with the remaining payments made on March 1 of each subsequent year. Which of the following accounts would be a credit in the March 1, Year 5, journal entry recorded by Handy Dandy?

Rent Revenue

Rent Expense

Lease Receivable

Deferred Rent Revenue

A

Deferred Rent Revenue

Handy Dandy would make the following journal entry on March 1, Year 5:

Cash 20,000
Deferred Revenue 20,000

100
Q
  • Neal Corp. entered into a 9-year operating lease on a warehouse on December 31, 20X1. Lease payments of $52,000, which includes real estate taxes of $2,000, are due annually, beginning on December 31, 20X2, and every December 31 thereafter.
  • Neal does not know the interest rate implicit in the lease; Neal’s incremental borrowing rate is 9%
  • . The rounded factor for the present value of an ordinary annuity for nine years at 9% is 6.

What amount should Neal report as a lease liability at December 31, 20X1?

$291,200

$468,000

$450,000

$312,000

A

$312,000

FASB ASC 842-20-30-1 requires capitalization of the present value of lease payments for operating and finance leases. The contract does not contain a separate nonlease component (FASB ASC 842-10-15-28 and 55-143) for the real estate taxes since they are not considered a separate good or service. Therefore, they are included in the payment.

Capitalized lease liability at
12/31/X1 (for nine years at 9%) =

$ 52,000 x 6 = $312,000

101
Q

Which of the following statements related to sale/leaseback transactions in which the transfer is not treated as a sale is correct?

The seller should derecognize the asset.

The buyer should account for any amounts paid as a financial liability.

The seller should account for any amounts received as a financial liability.

The buyer should recognize the transferred asset.

A

The seller should account for any amounts received as a financial liability.

  • When the transaction is not considered a sale, the seller/lessee should not derecognize the asset and should account for any amounts received as a financial liability.
  • The buyer should not recognize the transferred asset and should account for any amounts paid as a receivable.
102
Q

Which two conditions must be met for a contract modification to be accounted for as a new lease?

The right to use a new asset is obtained and the lease is priced at standalone market price.

All lease modifications must be accounted for as a termination of the existing lease and the beginning of a new lease.

The right to use a new asset is obtained and that right is priced at a discount to the current market price of that asset.

An existing right is extended and the extension is priced at standalone market price.

A

The right to use a new asset is obtained and the lease is priced at standalone market price.

Both a lessee and a lessor should account for a lease modification as a new lease, separate from the original lease, when the lease grants the lessee an additional right of use not included in the original lease, and the additional right of use is priced commensurate with its standalone price (in the context of that particular contract).

103
Q

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?

January

March

May

July

A

January

The commencement of a lease is the date of the lease agreement. Rental expense should begin as of that date.

104
Q

A 6-year finance lease entered into on December 31, 20X1, specified equal annual lease payments due on December 31 of each year. The first annual lease payment, paid on December 31, 20X1, consists of which of the following?

Both interest expense and lease liability

Lease liability

Neither interest expense nor lease liability

Interest expense

A

Lease liability

  • In general, each lease payment would consist of two elements—interest expense on the amount owed during the preceding period and reduction in lease liability
  • . In the case described, “interest expense” would be zero (because the time period December 31, 20X1, to December 31, 20X1, produces no interest charge) so all of the initial payment is attributed to reduction of lease liability.
105
Q
  • 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

A

$17,000

106
Q

For a right-of-use asset under a lease that contains a purchase option whereby it is reasonably certain the option will be exercised, the amortization period used by the lessee is:

the term of the lease.

the term of the lease or the estimated useful life of the asset, whichever is greater.

the term of the lease or the estimated useful life of the asset, whichever is shorter.

the estimated useful life of the asset at the commencement of the lease.

A

the estimated useful life of the asset at the commencement of the lease.

  • The inclusion of a purchase option which is reasonably certain to be exercised makes this a finance lease for the lessee.
  • As such, the lessee will retain ownership and possession of the asset after the end of the lease term.
  • Accordingly, the amortization period is the estimated useful life of the asset as of the beginning of the lease.
107
Q

Which of the following is a criterion for a lease to be classified as a finance lease in the books of a lessee?

The present value of the lease payments is 70% or more of the fair market value of the leased property.

The lease contains a purchase option that is reasonably certain to be exercised.

The lease term is less than a major portion of the estimated useful life of the leased property.

The lease does not transfer ownership of the property to the lessee.

A

The lease contains a purchase option that is reasonably certain to be exercised.

108
Q
A

$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

109
Q

For sales-type leases, which of the following statements is incorrect?

The lessor recognizes interest revenue at the beginning of the lease term.

The lessor recognizes selling profit at the beginning of the lease term.

The fair value of the asset must exceed the cost or carrying value of the asset for selling profit recognition.

Selling profit is the difference between sales revenue and cost of goods sold (essentially the same as gross profit)

A

The lessor recognizes interest revenue at the beginning of the lease term.

The lessor recognizes interest revenue over the lease term, not at the beginning of the lease term.

110
Q
  • On January 2, 20X1, Cole Co. signed an 8-year noncancelable lease for a new machine, requiring $15,000 annual payments at the beginning of each year.
  • The machine has a useful life of 12 years, with no salvage value. Title passes to Cole at the lease expiration date. Cole uses straight-line depreciation for all of its plant assets.
  • Aggregate lease payments have a present value on January 2, 20X1, of $108,000, based on an appropriate rate of interest.

For 20X1, Cole should record depreciation (amortization) expense for the leased machine at:

$15,000.

$0.

$13,500.

$9,000.

A

$9,000.

Depreciation (amortization)
expense for 20X1 = (“Cost” - Salvage) / Useful life
= $108,000 / 12 years
= $9,000

111
Q
  • Drew Company leased equipment to Remy Inc. under a five-year finance lease agreement that includes a purchase option effective at the end of the lease term that is expected to be exercised.
  • The equipment originally cost Drew $425,000 and has an expected economic life of 8 years and an expected residual value of $20,000 at the end of its economic life.

Using the straight-line method, what would Remy record as annual amortization?

$50,625

$85,000

$53,125

$81,000

A

$50,625

  • If a purchase option is reasonably certain to be exercised, the lessee includes the present value of the exercise price in determining the right-of-use (ROU) asset and liability.
  • However, payments are not given in this question, but rather the value of the asset and the residual value.
  • Remy would record annual amortization of $50,625.
  • The expected residual value of $20,000 is deducted from the cost of $425,000 and the remaining $405,000 is amortized over the eight-year economic life of the asset as it is expected that the purchase option will be exercised.
112
Q
  • On December 31, Year 6, Bradley Corp. sold a piece of land with a carrying cost of $1 million to Kravis Inc. for $2 million and simultaneously leased it back for 10 years with annual payments of $120,000 payable at the end of each year using a 5% discount rate.
  • The lease is appropriately recorded as a sale and leaseback transaction by both Bradley and Kravis. The market rates for the lease of the land are $90,000, payable annually at the end of each year.

On Bradley’s December 31, Year 6, balance sheet, the recognized gain from the sale of land would be:

$8,200.

$68,200.

$60,000.

$0.

A

$0.

Since the transaction is recorded as a sale/leaseback, the gain is recognized at the lease’s commencement on the income statement, not the balance sheet.

113
Q
  • 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

A

$63,000

114
Q

At the commencement of a finance lease, a guaranteed residual value that is probable should be:

included as part of lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.

excluded from lease payments.

included as part of lease payments at present value.

included as part of lease payments at future value.

A

included as part of lease payments at present value.

Per FASB ASC 842-10-30-5, at the commencement date, lease payments include fixed payments, variable lease payments, reasonably certain option exercise prices, payments for penalties, fees paid by the lessee to owners of a special-purpose entity, and amounts probable of being owed under residual value guarantees.

Note: The lessee includes in the payment only the amount of the guaranteed residual value that is probable of being owed. If the expected residual value will be greater than the guaranteed residual value, then the lessee can ignore it.

115
Q

Lessee residual value consideration:

Guaranteed residual values are included in the classification ___tests. (See section 2341.07.)

If it is probable that the expected residual value will be greater than the guaranteed residual value, the ___residual value can be ignored by the lessee in the computation of the lease liability.

If it is probable that the expected residual value will be less than the guaranteed residual value, the difference between the two should be ___by the lessee in the lease liability computation.

Lessees must ___lease payments when there is a change in the amount owed under a residual value guarantee.

A lease provision requiring the lessee to make up a residual value deficiency that is attributable to damage, extraordinary wear and tear, or excessive usages is similar to variable lease payments in that the amount is not determinable at the commencement date, and thus the provision does not constitute a lessee guarantee residual value. t/f

___residual values can be ignored by the lessee when measuring the lease liability.

A

present value

guaranteed

included

remeasure

True

Unguaranteed

116
Q

Residual Values

A residual value is an estimate of the value of an underlying asset at the ___of the lease term.

A guaranteed residual value is a guarantee made to a ___that the value of an underlying asset returned to the lessor at the end of the lease will be at least a specified amount.

Residual values can be guaranteed or unguaranteed by the lessee t/f

. Residual values are treated differently for the classification tests than they are for measurement. They can affect the amount of the lease payment, the classification of the lease, and the amounts recorded by the lessee and lessor.

A

end

lessor

trie

trie

117
Q

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

A

$798,000

118
Q

FASB Topic 842 lease accounting guidance defines a short-term lease as a lease that, at the commencement date, has a lease term under the contract of:

36 months or less.

48 months or less.

12 months or less.

24 months or less.

A

12 months or less.

The FASB defines a short-term lease as a lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. (FASB ASC Glossary)

119
Q

For an operating lease or finance lease, the amount recorded initially by the lessee as a liability should normally:

exceed the total of the lease payments.

equal the total of the lease payments.

equal the present value of the lease payments at the beginning of the lease.

exceed the present value of the lease payments at the beginning of the lease.

A

equal the present value of the lease payments at the beginning of the lease.

FASB ASC 842-20-30-1, in a discussion of accounting and reporting by lessees, notes that at commencement the lessee shall measure a lease liability at the present value of the lease payments not yet paid, discounted using the discount rate for the lease at lease commencement and the right-of-use asset.

120
Q

Which of the following statements about leases is incorrect?

The ROU asset and the lease liability are initially measured at present value of the lease payments.

One of the criteria for identifying a separate lease component is that the underlying asset is not dependent on the other underlying assets in the lease.

A lessee classifies a lease as either a finance or a sales-type lease at the commencement date.

Under FASB Topic 842, there are no “bright lines” for fair value (old 90% test) or asset life (old 75% test).

A

A lessee classifies a lease as either a finance or a sales-type lease at the commencement date.

The statement “A lessee classifies a lease as either a finance or a sales-type lease at the commencement date” is incorrect because lessees classify leases as operating or finance, not sales-type.

The other answer choices are correct statements:

  1. Under FASB Topic 842, there are no “bright lines” for fair value (old 90% test) or asset life (old 75% test).
  2. The right-of-use (ROU) asset and the lease liability are initially measured at present value of the lease payments.
  3. One of the criteria for identifying a separate lease component is that the underlying asset is not dependent on the other underlying assets in the lease.
121
Q

All of the following items are examples of common variable lease provisions, except:

usage of the underlying asset (e.g., miles on a leased car).

estimated life of the underlying asset.

external market rate or index (e.g., LIBOR).

performance of the underlying asset (i.e., percentage of revenue generated from leased asset).

A

estimated life of the underlying asset.

The estimated life of the underlying asset is a fixed amount and would not be an example of a variable provision.

The other answer choices are examples of common lease provisions:

  1. External market rate or index (e.g., LIBOR (London Interbank Offered Rate) or SOFR (Secured Overnight Financing Rate))
  2. Usage of the underlying asset (e.g., miles on a leased car)
  3. Performance of the underlying asset (i.e., percentage of revenue generated from leased asset)
122
Q

Variable Lease Payments

Variable lease payments are included in the measurement of the lease liability, and the related right-of-use (ROU) asset, if they are tied to a rate or index. T/F

Common examples include:

price changes due to changes in an external market rate or value of an index, such as the Consumer Price Index or benchmark interest rate.

the lessee’s performance derived from the underlying asset. For example, a lease payment may be based on a percentage of revenue obtained from the leased asset.

the use of the underlying asset; for example, with a car lease, an increase in or additional lease payment if miles exceed a specified mileage.

A

True

YEAH

123
Q

A lessor shall exclude from variable payment lessor costs paid by a lessee directly to a ___.

Costs paid to a third party by the ___and reimbursed by the __are treated as lessor costs that are to be considered variable payments by the lessor.

Variable lease payments that are included in the lessee’s lease liability and ROU asset are calculated using the index or rate at lease ___, with no increases or decreases to future lease payments during the term of the lease assumed.

Variable lease payments are unavoidable

A

third party

lessor , lessee

commencement

true

124
Q

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

A

$44,000

125
Q

What discount rate should public entity lessees use first when determining their discount rate?

Lessees should use their incremental borrowing rate.

Lessees should use their risk-free borrowing rate.

Lessees should first use the rate implicit in the lease, if known.

Lessees should use the rate implicit in the lease first, and then their risk-free rate if the implicit rate is not known.

A

Lessees should first use the rate implicit in the lease, if known.

  • Both lessees and lessors discount lease payments at the lease commencement date using the rate implicit in the lease.
  • If the lessee does not know the rate implicit in the lease, it can use its incremental borrowing rate.
  • Only nonpublic entities can use their risk-free interest rate as their incremental borrowing rate.
126
Q

Lease payments can fluctuate during the lease term, often based on the occurrence of a specified event. Which of the following is not an example of such an event?

Contingencies related to an external market rate

Contingencies related to technological advances

Contingencies related to asset usage

Contingencies related to revenues

A

Contingencies related to technological advances

  • Technological advances are generally not considered events which could trigger a change in lease payments.
  • he remaining answer choices (contingencies related to revenues, asset usage, and external market rates) are examples that could trigger a change in a year’s particular payment but not a change in the original measurement of the liability or receivable since these would be considered variable payments.
127
Q

On January 1, 20X1, Mollat Co. signed a 7-year lease for equipment having a 10-year economic life. The present value of the monthly lease payments equaled 80% of the equipment’s fair value. The lease agreement provides for neither a transfer of title to Mollat nor a purchase option. In its 20X1 income statement, Mollat should report:

lease amortization equal to 1/7th of 80% of the equipment’s fair value.

rent expense equal to the 20X1 lease payments less interest expense.

rent expense equal to the 20X1 lease payments.

lease amortization equal to 1/10th of the equipment’s fair value.

A

rent expense equal to the 20X1 lease payments.

In addition to transfer of title and purchase option, FASB ASC 842-10-25-2 provides three additional criteria for determining whether a lease is a finance lease:

  1. The present value of the sum of the lease payments and any lessee guaranteed residual value not already 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. In Mollat’s case the lease term is only 70% of economic life and the present value is only 80% of the equipment’s fair value. The lease is, therefore, an operating lease and the lease payments should be reported as rent expense.

128
Q
  • Crane Manufacturing leases a machine from Frank Leasing. Ownership of the machine returns to Frank after the 15-year lease expires. The machine is expected to have an economic life of 17 years.
  • t this time, Frank is unable to predict the collectibility of the lease payments to be received from Crane.
  • The present value of the lease payments exceeds 90% of the fair value of the machine.

What is the appropriate classification of this lease for Crane?

Leveraged

Installment

Operating

Finance

A

Finance

The lessee must classify a lease as a finance lease instead of an operating lease if any one of the following five criteria is met:

  1. The lease term is for the major part of the remaining economic life of the underlying asset. This criterion shall not be used if the lease commencement date is near the end of the asset’s economic life.
  2. The present value of the sum of the lease payments and any lessee guaranteed residual value not already in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.

Crane’s lease meets criteria 3. and 4. (only one is necessary). For the lessee, no other criteria have to be met. Crane is the lessee; therefore, the lease is a finance lease for Crane.

129
Q

Which of the following criterion is used by a lessee as a determinant for the classification of a lease as either finance or operating?

Whether the lease has an effective interest rate at least equal to the incremental borrowing rate of the lessee

Whether the lease contains variable lease payments

Whether the lessor’s interest rate implicit in the lease agreement is determinable from the terms of the lease

Whether the present value of the lease payments constitutes a significant portion of the fair value of the leased asset

A

Whether the present value of the lease payments constitutes a significant portion of the fair value of the leased asset

130
Q

Which rate should be used as a discount rate for leases?

Both the lessee and lessor must use the incremental rate.

Both the lessee and lessor must use the implicit rate.

The lessee can use the incremental rate if the implicit rate is unknown.

The lessee must use the incremental rate.

A

The lessee can use the incremental rate if the implicit rate is unknown.

Both lessees and lessors discount lease payments at the lease commencement date using the rate implicit in the lease.

Only the lessor must use the incremental rate; the lessee is permitted to use its incremental borrowing rate for purposes of discounting its lease payments if the lessee does not know the rate implicit in the lease.

131
Q

From the perspective of the lessor, which of the following statements is incorrect regarding nonoperating leases?

The lessor could account for the lease as a sales-type lease, with or without a selling profit.

For sales-type leases with selling profit, the lessor recognizes the profit ratably over the term of the lease.

For all sales-type leases, the lessor recognizes interest revenue over the lease term.

The lessor is required to derecognize the underlying asset at lease commencement.

A

For sales-type leases with selling profit, the lessor recognizes the profit ratably over the term of the lease.

  • For sales-type leases with selling profit, the lessor derecognizes the asset and records sales revenue, cost of goods sold, and a lease receivable (i.e., net investment in lease) at the beginning of the lease.
  • Selling profit is therefore also recognized at the beginning of the lease, not ratably over the term of the lease.
132
Q

In the long-term liabilities section of its balance sheet at December 31, 20X1, Mene Co. reported a finance lease obligation of $75,000, net of current portion of $1,364. Payments of $9,000 were made on both January 2, 20X2, and January 2, 20X3. 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 December 31, 20X2, balance sheet, what amount should Mene report as finance lease obligation, net of current portion?

$73,636

$74,250

$66,000

$73,500

A

$73,500

  • 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.
133
Q

Green Co. incurred leasehold improvement costs for its leased property. The estimated useful life of the improvements was 15 years. The remaining term of the nonrenewable lease was 20 years. These costs should be:

expensed as incurred.

capitalized and depreciated over 15 years.

capitalized and depreciated over 20 years.

capitalized and expensed in the year in which the lease expires.

A

capitalized and depreciated over 15 years.

The leasehold improvements will benefit a number of years and therefore must be capitalized and depreciated over the periods benefited.

The improvements are expected to have a useful life of 15 years and should be depreciated over that period since it is shorter than the remaining lease term.

134
Q

The lease term:

excludes any rent-free periods.

is never modified once determined at commencement of the lease.

includes all optional renewal periods.

begins at the commencement date.

A

begins at the commencement date.

The lease term includes any rent-free periods, begins at commencement, can change or be revised under certain lease modifications, and only includes optional renewal periods if there is “reasonable certainty” that the lessee has a significant economic incentive to exercise the option.

135
Q

Arena Corp. leased equipment from Bolton Corp. and correctly classified the lease as a finance lease. The present value of the lease payments at lease commencement was $1,000,000. The executory costs to be paid by Bolton were $50,000, and the fair value of the equipment at lease commencement was $900,000. What amount should Arena report as the finance lease obligation at the lease’s commencement?

$1,050,000

$1,000,000

$900,000

$950,000

A

$1,000,000

Absent additional information, executory costs are included in the amount capitalized as lease payments receivable by the lessor or obligation under a finance lease by the lessee since the contract does not contain a separate nonlease component (FASB ASC 842-10-15-28 and 55-143) for the real estate taxes since they are not considered a separate good or service.

The real estate taxes are expensed. Arena should report a finance lease obligation at $1,000,000.

136
Q
A

$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.

137
Q

On July 1, 20X1, South Co. entered into a 10-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, 20X2. In the notes to South’s June 30, 20X2, financial statements, what amounts of subsequent years’ lease payments should be disclosed?

$100,000 per annum for each of the next five years and $500,000 in the aggregate

$120,000 per annum for each of the next five years and $1,080,000 in the aggregate

$100,000 per annum for each of the next five years and $900,000 in the aggregate

$120,000 per annum for each of the next five years and $600,000 in the aggregate

A

$100,000 per annum for each of the next five years and $900,000 in the aggregate

  • FASB ASC 842-20-25-6 states that after commencement the lessee shall recognize a single lease cost, variable lease payments not included in the lease liability, and impairment.
  • Per illustrative guidance (FASB ASC 842-10-55-142), the operating costs are not considered components to the contract and are variable and recognized in profit or loss.
  • FASB ASC 842-20-50-6 provides that lessees disclose for operating leases a maturity analysis showing the undiscounted cash flows on an annual basis for each of the first five years and the total of the amounts for the remaining years.

South Co. should disclose a requirement to pay $100,000 during each of the next five years and a total of $900,000.

The building operating expenses paid by South (the lessee) are considered variable costs and are reported as period expense (i.e., not subject to disclosure within the liability but separately).

138
Q

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

A

$2,892

139
Q

A lessee-guaranteed residual value at the beginning of a finance lease should be:

  1. included by the lessor as part of lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.
  2. excluded from lease payments by both the lessee and lessor.
  3. included by the lessor as part of lease payments at future value.
  4. included by the lessee as part of lease payments at present value.
A

included by the lessee as part of lease payments at present value.

  • The guaranteed residual value is a promise made by the lessee to return a certain value to the lessor which the lessor desires to recover its investment in the asset.
  • When calculating the lease payments, the lessor includes the guaranteed residual value in the lease liability computation.
  • However, if the residual value of the asset at the end of the lease term is expected to be greater than the guarantee, the lessee can ignore the guaranteed residual value.
  • If the amount owed under a guaranteed residual value changes, the lessee must remeasure payments.
140
Q
A

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.

  1. Present Value, Annuity Due (PVAD): $42,500 at 7% for 4 periods = $42,500 × 3.62432 = $154,033
  2. 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)).

141
Q

Lease M does not contain a purchase option and the lease term is less than the majority of the estimated economic life of the leased property. The present value of the minimum lease payments is substantially less than the fair value of the leased asset’s fair value. The lessor will retain possession of the lease at the end of the lease term. The leased asset is a custom-made machine and has no alternative uses to the lessor. How should the lessee classify this lease?

None of the answer choices are correct.

As an operating lease

As a finance lease

As a leveraged lease

A

As a finance lease

The FASB lease standard establishes five criteria for classifying leases: (1) Ownership of the asset is transferred at the end of the lease; (2) the lease contains a bargain purchase option; (3) the lease term is for the majority of the economic life of the asset; (4) the present value of lease payments is substantially all or more of the fair value of the leased asset; and (5) the leased asset has no alternative uses.

If one or more of these conditions are present, the lease is a finance or sales-type lease. This lease is a finance lease because it has no alternative use.

142
Q

Generally, how would a lessee account for the impact of a lease modification?

A lessee would defer the impact of the modification and amortize it into income over the remaining lease life.

The lessee would record a gain or loss equal to the difference of the lease liability before and after the modification.

All lease modifications are accounted for as a new lease.

The lessee would revalue the lease liability and adjust it for the impact of the modification, and further adjust the ROU asset for the impact.

A

The lessee would revalue the lease liability and adjust it for the impact of the modification, and further adjust the ROU asset for the impact

The lessee must (1) reassess the lease classification as of the modification effective date. The lessee will (2) reallocate the remaining consideration in the contract and (3) remeasure the lease liability, using the relevant assumptions (e.g., discount rate) at the date of the modification.

143
Q

Which of the following statements related to FASB Topic 842 is correct?

For lessees, applying Topic 842 results in the recognition of a right-to-use asset and lease liability for all leases, except those specifically scoped out of the standard.

Full convergence was achieved with the applicable international lease accounting standard.

The income statement treatment for all leases is identical for lessees.

Topic 842 results in significant changes in lessor accounting for leases.

A

For lessees, applying Topic 842 results in the recognition of a right-to-use asset and lease liability for all leases, except those specifically scoped out of the standard.

Per FASB ASU 2016-02, the main difference between previous GAAP and FASB Topic 842 is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP.

FASB ASC 842 primarily focused on changes to lessee accounting, not lessor accounting. The income statement treatment is different depending on the lease classification. Lastly, full convergence with international standards was not achieved.

144
Q
A