Unit 13 questions

Question 1

For a lease accounted for under IFRS to be classified as a finance lease, it must have one of the following:

Answer 1

(1) The lease provides for the transfer of ownership of the leased asset by the end of the lease term;
(2) the lease contains a bargain purchase option, and it is reasonably certain that the option will be exercisable;
(3) the lease term is for the major part of the economic life of the leased asset;
(4) the present value of the minimum lease payments is at least equal to substantially all of the fair value of the leased asset at the inception of the lease; or
(5) the leased asset is such that it can be used only by the lessee without major modification.

Question 2

What is included in the minimum lease payments?

Answer 2

• PV Annual rent payment (exclude executory costs)
• PV Bargain purchase option
• PV Guaranteed residual value

Question 3

At its inception, the lease term of Lease G is 65% of the estimated remaining economic life of the leased property. This lease contains a bargain purchase option. The lessee should record Lease G as

Answer 3

An asset and a liability.

Question 4

A lessee should compute the present value of the minimum lease payments using its incremental borrowing rate unless:

Answer 4

• The lessee knows the lessor’s implicit rate, and
• The lessor’s implicit rate is less than the lessee’s incremental borrowing rate.

Question 5

For a capital lease, the present value of the minimum lease payments should be recorded at the inception date. The minimum lease payments exclude:

Answer 5

executory costs, such as insurance, maintenance, and taxes.

Question 6

For a capital lease, the amount recorded initially by the lessee as a liability should normally

Answer 6

Equal the present value of the minimum lease payments at the beginning of the lease.

Question 7

if a third party has guaranteed to pay a residual value at the end of the lease, is this included in minimum lease payments by the lessee?

Answer 7

No, it is not included in the minimum lease payments by the lessee.

Question 8

On January 1, Blaugh Co. signed a long-term lease for an office building. The terms of the lease required Blaugh to pay $10,000 annually, beginning December 30, and continuing each year for 30 years. The lease qualifies as a capital lease. On January 1, the present value of the lease payments is $112,500 at the 8% interest rate implicit in the lease. In Blaugh’s December 31 balance sheet, the capital lease liability should be

A.$112,500

B.$111,500

C.$102,500

D.$290,000

Answer 8

Answer (B) is correct.
A lease payment has two components: interest expense and the portion applied to the reduction of the lease obligation. The effective-interest method requires that the carrying amount of the obligation at the beginning of each interest period be multiplied by the appropriate interest rate to determine the interest expense. The difference between the minimum lease payment and the interest expense is the amount of reduction in the carrying amount of the lease obligation. Consequently, interest expense is $9,000 ($112,500 BOY liability balance × 8% implicit rate), and the reduction in the lease obligation is $1,000 ($10,000 cash – $9,000 interest expense). The new balance of the lease obligation is thus $111,500 ($112,500 – $1,000).

Question 9

Glade Co. leases computer equipment to customers under direct-financing leases. The equipment has no residual value at the end of the lease, and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a 5-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for 5 years is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease?

A.$139,450

B.$75,000

C.$129,360

D.$51,600

Answer 9

Answer (D) is correct.
To earn 8% interest over the lease term, the annual payment must be $75,000 ($323,400 fair value at the inception of the lease ÷ 4.312 annuity factor). Given no residual value and no bargain purchase option, total lease payments will be $375,000 ($75,000 payment × 5 years). Because this is a direct-financing lease, the fair value is presumably equal to the carrying amount, so no dealer’s profit will be recognized. The entire difference between the gross lease payments received and their present value is treated as interest revenue ($375,000 – $323,400 = $51,600).

Question 10

Rent should be reported by the lessor as revenue over the lease term as it becomes receivable according to the provisions of the lease for a(n)

• Direct-Financing Lease
• Operating Lease
• Sales-Type Lease

Answer 10

• Direct-Financing Lease- No
• Operating Lease- yes
• Sales-Type Lease- No

For capital leases (direct financing and sales-type leases), income is recognized in accordance with the interest method. Income equals the carrying amount for the period multiplied by an appropriate interest rate. For an operating lease, rent is ordinarily reported as income in accordance with the lease agreement, that is, as the rent becomes receivable. However, if rentals vary from a straight-line basis, the straight-line basis should be used unless another systematic and rational basis is more representative of the time pattern in which the use benefit from the property is reduced.

Question 11

following entry at the inception of a lease:

DR: Lease payments receivable

CR: Asset

CR: Unearned interest revenue

Answer 11

A direct-financing lease by a lessor.

Question 12

In a lease that is recorded as a sales-type lease by the lessor, interest revenue

Answer 12

Should be recognized over the period of the lease using the effective-interest method.

The difference between the gross investment in the lease and the sum of the present values of the components of the gross investment is recorded as unearned income. This unearned income is amortized to income over the lease term using the effective-interest method, which produces a constant periodic rate of return on the net investment.

Question 13

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

Answer 13

The minimum lease payments plus residual value.

The lessor may use the net method or the gross method of accounting for a direct-financing lease. If the lessor elects the net method, it debits the receivable at the inception of the lease for the sum of the present values of (1) the minimum lease payments (including any guaranteed residual value) and (2) any unguaranteed residual value. The credit is to the leased asset. No sales revenue is recognized because the lease is a direct-financing, not a sales-type, lease. If the lessor elects the gross method, the lease receivable equals the sum of the undiscounted lease payments, and an additional credit is made to unearned interest income.

Question 14

The excess of the fair value of leased property at the inception of the lease over its cost or carrying amount should be classified by the lessor as

Answer 14

Manufacturer’s or dealer’s profit from a sales-type lease.

In a sales-type lease, the cost, or carrying amount if different, plus any initial direct costs, minus the present value of any unguaranteed residual value, is charged against income in the same period that the sales price (present value of the minimum lease payments) is recognized. The result is the recognition of a net profit or loss on the sales-type lease. Thus, by definition, a sales-type lease is one that gives rise to a manufacturer’s or dealer’s profit (or loss) because the fair value of the leased property at the inception of the lease (the present value of the minimum lease payments) differs from its cost or carrying amount.

Question 15

In a sales type lease, the lessor should report a profit. The gross profit equals the difference between the:

Answer 15

sales price (present value of the minimum lease payments) and the cost.

Question 16

If a company uses off balance sheet financing, that means that assets have been acquired with:

Answer 16

Operating leases.

With an operating lease, no long-term liability need be reported on the face of the balance sheet.

Question 17

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

Answer 17

Over the life of the lease.

Given that the lease bonus is nonrefundable, it should be considered part of the rental payments. Regardless of when the rental payments are actually received, the lessor should recognize rental revenue on a straight-line basis over the lease term.

Question 18

A lease is classified as a capital lease because it contains a bargain purchase option. Over what period of time should the lessee amortize the leased property?

Answer 18

The economic life of the asset.

An asset recorded under a capital lease by the lessee must be depreciated in a manner consistent with the lessee’s normal depreciation policy. If the lease is capitalized because the lease either

(1) TT or
(2) BPO, the depreciation of the asset is over its entire estimated economic life.

Question 19

If the lease does not qualify for a capital lease but the lessee make long term improvements to the leased property, what should be done?

Answer 19

General improvements to leased property should be capitalized as leasehold improvements and amortized in accordance with the SL method over the short of their expected useful or the lease term.

Question 20

how should future minimum lease payments be presented on the BS? So if $100 per year for 8 years how would this be shown?

Answer 20

The future minimum lease payments as of the date of the latest balance sheet presented must be disclosed in the aggregate and for each of the 5 succeeding fiscal years. This disclosure is required whether the lease is classified as a capital lease or as an operating lease. (executory costs are not included in the minimum lease payments)

$100*5=$500 amount for appropriate required period

100*3=300 aggregate amount for the period thereafter

Question 21

Under the conservatism restraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. Thus, a loss, not a gain, contingency may be recorded in the financial statements. If the probability of realization of a gain is high:

Answer 21

contingency is disclosed in the notes.

Question 22

A material contingent loss must be accrued when the following two conditions are met:

Answer 22

• It is probable that, at the balance sheet date, an asset has been impaired or a liability has been incurred.
• The amount of the loss can be reasonably estimated.

Question 23

A debt guarantee that represent a remote possiblity of loss is accrued, disclosed or both?

Answer 23

Accrued and disclosed.

Question 24

for IFRS: if a range of loss is given what number do we take?

Answer 24

take the mid point number.

Question 25

How is a remote loss contingency recorded?

Answer 25

Need not be disclosed or accrued.

Question 26

Subsequent events are events or transactions that occur after the balance sheet date and prior to the issuance or availability of the financial statements. Subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet are not required to be recognized, but it may require a:

Answer 26

disclosure.

Question 27

On November 1, Year 4, Davis Co. discounted with recourse at 10% a 1-year, noninterest-bearing, $20,500 note receivable maturing on January 31, Year 5. What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, Year 4?

A.$20,000

B.$0

C.$20,333

D.$20,500

Answer 27

Answer (D) is correct.
When a note receivable is discounted, the receivable is removed from the accounts, a gain or loss is recognized, and a contingent liability is disclosed in a note. If the receivables are not paid, Davis Co. may be responsible for the full amount of the note $(20,500). Consequently, this amount should be disclosed in the notes.