Intermediate II - Chapter 15 - Leases

Smith Company leased equipment from FirstLease Corp. The cost of the equipment to FirstLease was $500,000. The present value of the expected residual value is $40,000. The lease includes six annual payments beginning on the first day of the lease. If the six lease payments are of an equal amount, what payment amount would provide FirstLease Corp with a return of 10%?

$96,018 Reason: $500,000-40,000 = $460,000/4.79079 = $96,018

Which of the following are required disclosures related to leases?

1 .nonlease payments 2. residual values 3. variable lease cost

In a sales-type lease with selling profit, the lessor would also record >>>>

1. cost of goods sold 2. sales revenue

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over three years of the equipment's five-year estimated useful life. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The present value of the lease payments is $357,710. The annual lease payment is $100,000; the first payment is due on January 1, 20X1. Franz should recognize the first lease payment by ______debiting _________and crediting ____________________.

1. debiting cash for $100,000 2. crediting deferred lease revenue for $100,000

Finance/Sales type lease-1st and 2nd payments-for lessor -

1st Payment 1. Debit cash for exact lease payment - $100,000 2. Credit lease receivable for exact lease payment - $100,000 2nd Payment 1. Debit cash for exact lease payment - $100,000 2. Credit interest revenue (interest X total PV of lease payments - exact lease payment) 3. Credit lease receivable for difference between exact lease payment and interest revenue

The lessor ___________ record a lease receivable in an operating lease.

DOES NOT!!!!!!!

Match the treatment of initial direct costs incurred by the lessor with the correct lease classification. Sales-type lease with no selling profit ........

Deferred and expensed over the lease term by increasing the lease receivable

Match the treatment of initial direct costs incurred by the lessor with the correct lease classification. Operating lease ..........

Deferred and expensed over the lease term typically on a straight-line basis

True or false: The residual value of a leased asset always impacts the lessee's accounting.

False Reason: The lessee's accounting is unaffected by the residual value other than it causes the lessee's payments to be lower.

Which of the following type of leases follows the same accounting method as that of an installment purchase?

Finance lease

How is lease revenue recorded by the lessor in an operating lease?

On a straight-line basis

Unguaranteed residual value -

PV - (1) influences the size of the lease payments (2) added to lease receivable (3) subtracted from sales revenue and COGS in sales-type lease

Excess of guaranteed residual value over expected residual value -

PV - (1) influences the size of the lease payments (2) added to right-of-use asset and lease liability

Journal entries for lessor on sales-type lease with residual value >>>>>> Debit lease receivable _____________

PV of lease payments plus the PV of the residual value

The journal entries for a lessor on a sales-type lease >>>>>> Debit lease receivable _______________

PV of lease payments plus the PV of the residual value

Leasehold Improvement

account title when a lessee makes improvements to leased property that reverts back to the lessor at the end of the lease.

Initial direct costs incurred by the lessee are _________________________.

added to the right-of-use asset.

In a sales type lease, if a cash payment is expected under a lessee-guaranteed residual value is predicted >>>>> the lessee

adds the PV of the difference of that payment to the periodic lease payments that the lessee records as both a right-of-use asset and a lease liabilty at the beginning

The lessor's accounting is ____________ by the residual value in a sales-type lease.

affected

In an operating lease, initial direct costs __________

are deeferred and expensed over the lease term, generally on a straight-line basis.

In a sales-type lease with no selling profit, initial direct costs _________

are deferred and expensed over the lease term. This is done by including it in the lease receivable.

The rights a lease grants a lessee under any lease, whether classified as a finance lease or an operating lease __________________.

are different from the rights transferred in the outright purchase of and asset.

If the lease payments have a total value that represents "substantially all" of the asset's fair value, it is logical to identify the contract as ____________.

equivalent to a sale.

An additional cash payment is _____ when a bargain purchase option is included in the lease agreement.

expected

Corr Inc. leases equipment from LM Leasing Corp. The lease requires rental payments of $20,000 per year for 5 years. Title of the property transfers at the end of the lease term. The equipment has a useful life of 10 years. How should the lease be classified by Corr?

finance lease Reason: Since title transfers at the end of the lease term, the lease is a finance lease.

If the PV of the lease payments, including any lessee-guaranteed residual value, constitutes "substantially all" of the fair value of the asset, it is a ______________ lease from the lessee's perspective and a ___________ lease from the lessor's perspective.

finance lease - lessee sales-type lease - lessor

operating leases

fundamental rights and responsibilities of ownership are retained by the lessor and the lessee merely is using the asset temporarily.

Agatha Corp. leases store space from Christie Company. Agatha agrees to pay $10,000 per month. In addition, if Agatha exceeds specified sales targets, it will pay additional monthly rent based on a percentage of those excess sales. The additional rent payments _________________________.

have no effect on the lessee's lease liability and lessor's lease receivable.

The desired rate of return for the lessor when determining the lease payments is referred to as the _____ interest rate.

implicit

The effective interest rate of return the lease payments provide the lessor is referred to as the _________

implicit rate.

Legal fees for executing lease documents, and the preparation and processing cost of lease documents are referred to as ___________.

initial direct costs.

From an accounting standpoint, legal ownership of a leased asset is _____ to the accounting method used.

irrelevant

Glueck Inc. leases an asset with a cost of $200,000 to Perl Company. The present value of the annual lease payments is $320,000 and control of the asset is transferred to Perl Company. At the commencement of the lease, Glueck should debit: _______________________.

lease receivable for $320,000

When there is a change in the lease term, the _____ is required to reassess the classification of the lease. A _____ is not permitted to reassess its initial determination of the lease term.

lessee ; lessor

A lessee makes leasehold improvements to leased property that will revert back to the lessor at the end of the lease. During the term of the lease, the leasehold improvements are reported on the __________________.

lessee's balance sheet as an asset.

The _____ must disclose their lease transactions and regular transactions separately.

lessor

The _____ subtracts the present value of a bargain purchase option price to determine the amount that must be recovered through the periodic rental payments

lessor

The _____ subtracts the present value of a bargain purchase option price to determine the amount that must be recovered through the periodic rental payments.

lessor

The right-of-use asset is amortized straight-line, unless the lessee's ________ of using the asset is different.

pattern or manner

When recording a finance lease, the amount initially recognized for the right-of-use asset is the _______________.

present value of the lease payments

In a typical finance lease, the first lease payment at the beginning of the lease consists of _________________.

reduction in principal only

In a sales-type lease, we ignore the residual value when there is a BPO - bargain purchase option because _____________

the bargain purchase option is expected to be exercised, therefore, the titled of the leased asset is passed to the lessee and also the residual value.

If a lease contains a bargain purchase option, the lessee should amortize the right-of-use asset over _______________

the useful life of the asset.

The lesseee's accounting is _____________ by the residual value in a sales-type lease.

unaffected

selling profit

when the fair value of the asset (usually the present value of the lease payments, or "selling price") exceeds the cost or carrying value of the asset sold.

In which of the following ways can a lease be accounted for?

1. As a purchase/sale agreement with debt financing. 2. As a rental agreement.

Journal entries for lessee on $60,000 purchase option >>>>>>>

1. Debit cash for $60,000 Reason: exercise price 2. Credit lease payable for $54,542 Reason: difference (balance of lease payable after all periodic lease payments have been made 3. Credit interest expense for $5,458 Reason: 10% interest (10% X $54,542)

Ludwig Corporation leases a machine to Kluge Corporation under a three-year lease agreement determined to be a finance/sales-type lease. At the inception of the lease +++++++

1. Kluge records a lease payable. 2. Kluge records a right-of-use asset.

A finance lease is economically similar to a purchase of the asset because the terms of a finance lease _____________________

1. allow the lessee to direct the use of the asset in a way that the lessee receives substantially all of the remaining benefits from the asset. 2. creates obligations for the lessee that are similar to those that financing the purchase of an asset would impose.

Initial direct costs include _______________

1. costs that would not have been incurred if the lease agreement did not exist 2. costs associated with completing the lease agreement 3. costs necessary to acquire the lease

If it is reasonabley certain that the lessee witll exercise the purchase option, the accounting for the lease is affected in 3 ways :

1. the lease is classified as a finance/sales-type lease 2. both the lessee and the lessor consider the exercise price of the option to be an additional cash payment 3. we assume the lease term ends on the date that the option is expected to be exercised

Match the treatment of initial direct costs incurred by the lessor with the correct lease classification. Sales-type lease with selling profit .........

Expensed at the beginning of the lease

Lease payments include -

FIXED PAYMENTS - 1. plus exercise price for purchase option is exercise reasonably certain 2. plus termination penalty for termination option if exercise reasonably certain 3. plus variable lease payments on if deemed in-substance fixed payments or based on index or rate when contract remeasured for another purpose 4. plus excess of guaranteed residual value over expected residual value

leasehold improvements .......

If a lessee makes improvements to leased property that reverts back to the lessor at the end of the lease. This cost represents an asset. Its cost is allocated as amortization or depreciation expense over the useful life to the lessee - the shorter of the lease term or the physical life of the asset.

Purchase options -

If exercise is "reasonably certain": - limits lease term - PV of exercise price added to right-of-use asset and lease liability - PV of exercise price added to lease receivable

Variable lease payments -

Included only if payments are (1) in-substance fixed payments (2) based on index rate - when contract reassessed

Journal entries for lessor on sales-type lease with residual value >>>>>> Credit inventory ___________

Lessor's cost of equipment

The journal entries for a lessor on a sales-type lease >>>>>>>> Credit inventory ______________

Lessor's cost of equipment

Journal entries for lessor on sales-type lease with residual value >>>>>> Debit cost of goods sold ____________

Lessor's cost of the equipment less the PV of the residual value

The journal entries for a lessor on a sales-type lease >>>>>> Debit cost of goods sold __________________

Lessor's cost of the equipment less the PV of the residual value

Journal entries for lessor on sales-type lease with residual value >>>>> Credit sales revenue _____________

Sales less the PV of the residual value

The journal entries for a lessor on a sales-type lease >>>>>>>> Credit sales revenue _______________

Sales less the PV of the residual value

Which method should normally be used to amortize the right-of-use asset?

Straight-line

How does a residual value in a finance/sales-type lease affect the lessor?

The lessor includes the residual value in lease receivable computations regardless of guarantee.

If the lease term includes a bargain purchase option that is reasonably expected to be exercised, when does the lease term end for accounting purposes?

When the option becomes exercisable.

The _____ adds the present value of the bargain purchase option to the present value of periodic rental payments when computing the amount to be recorded as a right-of-use asset and a lease liability.

lessee

Journal entries for lessor on $60,000 purchase option >>>>>>>>

1. Debit cash for $60,000 Reason: exercise price 2. Credit lease receivable for $54,542 Reason: account balance 3. Credit interest revenue for $5,458 Reason: 10% interest (10% X $54,542)

Finance/Sales type lease - Beg of lease- for lessor -

1. Debit lease receivable for total of PV of lease payments 2. Credit equipment for lessor's cost (carrying amount) Note : PV of annuity due of $1

Finance/Sales type lease - Beg of lease - for lessee -

1. Debit right of use asset for total PV of lease payments 2. Credit lease payable for total PV of lease payments Note : PV of annuity due of $1

Which of the following are criteria for classification as a finance lease?

1. The lease includes a purchase option the lessee is reasonably certain to exercise. 2. Ownership of the asset transfers to the lessee. 3. The present value of the total lease payments is greater than substantially all of the fair value of the asset.

In an operating lease, the lessor >>>>>>

1. does not record a lease receivable at the beginning of the lease 2. does not remove the asset being lease from its balance sheet 3. records straight-line revenue as a single lease revenue amount equal to the payment the lessee records as lease expense 4. depreciated the asset over the assets useful life, just like any other asset.

Glueck Inc. leases an asset with a cost of $200,000 to Perl Company. The present value of the annual lease payments is $320,000 and control of the asset is transferred to Perl Company. At the commencement of the lease, Glueck should credit: _______________ and ________________.

1. equipment for $200,000 2. sales revenue for $320,000

Which of the following would be included in the lessor's gross investment in the lease?

1. periodic lease payments 2. residual value

Finance/Sales type lease -1st and 2nd payments-for lessee -

1st Payment 1. Debit lease payable for exact lease payment - $100,000 2. Credit cash for exact lease payment - $100,000 2nd Payment 1. Debit interest expense (interest X total PV of lease payments - exact lease payment) 2. Credit cash for exact lease payment 3. Debit lease payabble for difference between exact lease payment and Interest expense

True or false: When a bargain purchase option is present, the lessor subtracts the future value of the exercise price from the amount to be recovered to determine the amount to be recovered through rental payments.

False Reason: The lessor subtracts the present value.

Lease term includes -

NON-CANCELABLE PERIOD - 1. plus periods covered by renewal option if exercise is reasonably certain 2. Minus periods following date opurchase option if exercise is reasonably certain 3. plus periods covered by renewal options if under control of lessor 4. plus periods following date of termination option if reasonably certain option will NOT be exercised.

The lease term -

Noncancelable period for which the lessee has the right to use an underlying asset, modified by any renewal or termination options reasonably certain to be exercised. Options under control of lessor are automatically included. Reassessed when significant occurence indicates a change in economic incentive

Lessee guaranteed residual value -

PV - (1) considered when determining lease classification (2) included in lease receivable (3) included insales revenue

How should the lessee account for an expected cash payment when the value of the leased asset at the end of the lease is expected to be less than the guaranteed residual value?

The lessee should increase the right-of-use asset and lease liability by the present value of the expected cash payment.

purchase option

a provision of some lease contracts that gives the lessee the option of purchasing the leased property during, or at the end of, the lease term at a specified price.

The rights granted to a lessee under a finance lease ________ the same as those granted to a company that purchases an asset.

are not

Depending on the nature of the leasing arrangement, a lease is accounted for _________

as a rental or a purchase/sale.

A guaranteed residual value ___________ the calculation of the present value of the lease payments when comparing that amount to the fair value of the asset in determining lease classification.

is included in

The short-cut method may be applied only if the maximum possible lease term is _________

less than or equal to twelve months

Lease payments are often _______________than installment payments.

lower, less, or cheaper

The lease term is typically considered to be _________________.

the contractual term of the lease plus any periods covered by options to extend if extension is reasonably certain to occur.

When a leased asset is returned at the end of the lease term and the actual residual value is less than the initial estimated residual value, _____ for the difference between estimate and actual.

the lessor records a loss

Which of the following are possible reasons for leasing an asset rather than purchasing an asset?

1. Lower periodic payments on the asset 2. Tax benefits 3. No additional fees 4. Avoiding the risk of decreasing selling prices

When are the right-of-use asset and lease liability remeasured and adjusted for changes in the amount of payments due to a change in index or rate?

1. When the lease is modified giving the lessee an additional right-of-use 2. When the lease term is reassessed and changed

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over three years of the equipment's five-year estimated useful life. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The present value of the lease payments is $357,710. The annual lease payment is $100,000; the first payment is due on January 1, 20X1. Tucker should recognize the first lease payment by debiting ______________________ and crediting ___________________.

1. crediting cash for $100,000 2. debiting lease payable for $100,000

Which of the following are required disclosures for lessees and lessors?

1. future payments for total remaining years 2. future payments in each of the next 5 years 3. description of the leasing arrangements

Which one of the following will determine classification of a lease transaction as a finance lease?

The asset is of a very specialized nature and will have no alternative use to the lessor.

What interest rate is used to compute the present value of the remaining lease payments when a lease term is reassessed and changed?

The lessee's incremental borrowing rate at the time of the reassessment

In an operating lease, who reports the leased asset on their balance sheet?

The lessor

A leasehold improvement should be depreciated or amortized over _____.

the shorter of the physical life of the asset or the lease term.

Taylor Company leased an asset from Lease Corp. using an operating lease for equipment with a useful life of seven years. The initial lease term was for three years. After two years, Taylor Company and Lease Corp. agree to extend the lease term by four years, and to change the amount of lease payments. The additional four years were not originally an option. The increase in present value of lease payments for Taylor is $200,000. The present value of the remaining lease payments for Lease Corp is $300,000. The initial cost of the equipment to Lease Corp was $500,000. The useful life of the equipment is estimated to be seven years and depreciation is computed straight-line with no residual value. How should Lease Corp account for this lease modification?

1. credit sales revenue for $300,000 Reason: present value of remaining lease payments 2. credit asset for $500,000 Reason: to remove asset from books 3. debit lease receivable for $300,000 Reason: to remove remainder of original lease payments 4. debit cost of goods sold for $357,143 Reason: original cost minus accumulated depreciation 5. debit accumulated depreciation for $142,857

On January 1, Year 1, Samuel Company leases equipment from Lease Corp. The lease agreement specifies five annual payments of $50,000, with the first payment due at lease signing (January 1, Year 1), and at each January 1 from Year 2 to Year 5. At the end of the lease term, the equipment will be returned to the lessor and is expected to have a residual value of $30,000. The estimated useful life of the equipment is six years. The interest rate in the financing arrangement is 6%. The cost to Lease Corp of manufacturing the equipment is $150,000. The journal entry for the Lessor on January 1, Year 1 will include the following in its entry: ___________________

1. debit lease receivable $245,673 Reason: PV of payments: $50,000 x 4.46511 = $223,255 plus the PV of residual: $30,000 x 0.74726 = $22,418 = $245,673 2. credit sales revenue $223,255 Reason: PV of the lease payments 3. credit equipment $150,000 Reason: Cost of the equipment to lessor

Taylor Company leased an asset from Lease Corp. using an operating lease for equipment with a useful life of seven years. The initial lease term was for three years. After two years, Taylor Company and Lease Corp. agree to extend the lease term by four years, and to change the amount of lease payments. The additional four years were not originally an option. The increase in present value of lease payments for Taylor is $200,000. The present value of the remaining lease payments for Lease Corp is $300,000. The initial cost of the equipment to Lease Corp was $500,000. The useful life of the equipment is estimated to be seven years and depreciation is computed straight-line with no residual value. How should Taylor account for this lease modification?

1. debit right-of-use asset for $200,000 Reason: The increase in right-of-use asset and lease payable for the lessee is the increase in present value of lease payments. 2. credit lease payable for $200,000 Reason: This is the lessor's accounting

In a sales-type lease that includes selling profit, initial direct cost _______

are expensed in the period of sale - the beginning of the lease

If a purchase option is expected to be exercised and the lessee is predicted to own the asset after the lease term ---------------

the right of use asset recognized by the lessee should be amortized over the economic life of the asset, rather than over the lease term

A lease structured as an installment purchase is called a(n) _________ lease by the lessee.

finance or financing