Week 4

Harry Potter Barn (HPB) leased equipment from Sorcerer's Leasing Co. on January 1, 2021, in a sales-type lease. There is no transfer of ownership or bargain purchase option. The present value of the lease payments discounted at 10% was $80,000. Ten annual lease payments of $12,000 are due each January 1, beginning at the time of the signing of the leasing contract. The total decrease in earnings (pretax) in HPB's Dec. 31, 2021, income statement would be: Select one: a. $7,400 b. $14,800 c. $9,000 d. $12,000

$6,800 Interest expense: ([10% ] x [$80,000 - 12,000]) + 8,000 Amortization expense: ($80,000/10) = $14,800

On January 2, 2021, 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. For the year ended December 31, 2021, what amount should Nori recognize as amortization expense on the right-of-use asset? Select one: a. $27,500 b. $30,000 c. $48,000 d. $46,000

In a finance lease with a purchase option that is reasonably certain to be exercised, the lessee will control the asset for its entire useful life. Therefore, the amortization should be allocated over the 8-year life of the asset. $240,000 cost − $20,000 salvage value = $220,000 ÷ 8 years = $27,500 per year.

Durney Co. recorded a right-of-use asset of $800,000 in a ten-year finance lease. The first payment is due at the time of the signing of the leasing contract. The interest rate charged by the lessor was 10%. There is no residual value at the end of the lease term. The balance in the right-of-use asset after two years will be: Select one: a. $648,000 b. $640,000 c. $880,000 d. $968,000

In a finance lease, the lessee amortizes its right of use asset on a straight line basis. In this case, amortization is $800,000 ÷ 10 years, or $80,000 per year. So, after 2 years, the balance will be $800,000 − $160,000 = $640,000.

The lessee's option to purchase a leased asset at a price that is sufficiently lower than the asset's expected fair value so that the exercise of the option appears reasonably certain sometimes is called a: Select one: a. Bargain purchase option b. Lessee buy-out option c. Lessor sell-out option d. Guaranteed purchase option

a. Bargain purchase option

When lessors account for residual values related to leased assets, they Select one: a. include the residual value in the receivable measurement because it is assumed the residual value will be realized. b. include the unguaranteed residual value in sales revenue c. recognize more gross profit on a sales-type lease with a guaranteed residual value than on a sales-type lease with an unguaranteed residual value. d. reduce the residual value by the executory costs

a. include the residual value in the receivable measurement because it is assumed the residual value will be realized.

Correct Mark 1.00 out of 1.00 Flag question Question text ABC Books is the lessor in a lease agreement. From the perspective of the lessor, the lease may be classified as: Select one: a. operating or sales-type b. operating or finance c. operating, sales-type, indirect financing d. operating, finance, or sales-type

a. operating or sales-type

Knottworth Gedding Consulting leased machinery from Red Inc. on July 1, 2021. The lease was recorded as a finance lease. The present value of the lease payments discounted at 10% was $40.5 million. Ten annual lease payments of $6 million are due each July 1 beginning July 1, 2021. What amount of interest expense from the lease should Knottworth Gedding report in its December 31, 2021, income statement? Select one: a. $2,025,000 b. $1,725,000 c. $1,650,000 d. -0-

b. $1,725,000 10% x ($40,500,000 - 6,000,000) x 6/12 = $1,725,000

Omega leased a machine for a ten-year non-cancelable term. At the end of the ten-year term, Omega has five consecutive one-year renewal options. A replacement machine can be acquired at the end of the term for the leased machine, but due to an expensive installation process and Omega's lease term for its store, Omega expects to lease the machine for 12 years. What is the lease term? Select one: a. 10 years b. 12 years c. 11 years d. 15 years

b. 12 years The lease term consists of ten years plus two renewal years, or 12 years, because the expensive installation now means that Omega is reasonably certain to exercise two of its one-year renewal options.

BookCook Company leases an asset. Information regarding the lease: • Fair value of the asset: $400,000. • Useful life of the asset: 6 years with no salvage value. • Lease term is 5 years. • Present value of the total annual lease payments are $60,000 • Fair market value of the leased asset is 70,000. • BookCook can purchase the asset at the end of the lease period for $50,000. For BookCook, what type of lease is this? Select one: a. Operating b. Finance c. Short term d. Sales-type

b. Finance The 5-year lease term is for the major part of the asset's 6-year life making this a finance lease. (Criterion 3) Note that Criterion 4 is not met (60,000/70,000<90%), and we don't know if there is a bargain purchase option (although we know there is a purchase option, we don't know whether it is reasonably certain that the lessee (BookCook) will exercise this option, because we don't know the estimated fair value of the asset at the end of the lease term.)

Leasing has become the number one method of external financing by U.S. companies. Reasons include each of the following except: Select one: a. From the lessor's perspective, point-of-sale advantage in finding leasing customers for captive leasing companies b. From the lessee's perspective, extended use of the asset c. From the lessee's perspective, protection against obsolescence d. From the lessee's perspective, lower upfront cash needed to use an asset e. From the lessor's perspective, potential high residual value at the end of the lease term

b. From the lessee's perspective, extended use of the asset

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2021 for the purpose of leasing a machine to be used in its manufacturing operations. If Alt accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2021? Select one: a. Amortization Expense b. Lease Expense c. Interest Expense d. Amortization Expense and Interest Expense

b. Lease Expense

Under a sales-type lease, the lessor reports cash receipts on the statement of cash flows as part of: Select one: a. Financing Activities b. Operating Activities c. Investing Activities d. Non-Cash Activities

b. Operating Activities Under a sales-type lease, we assume that the lessor is actually selling a product. Therefore, the receipts are included as part of operating activities.

If the lessee expects to obtain title to leased property due to a purchase option that is reasonably certain to be exercised or the passage of title at the end of the lease term Select one: a. The lessee ignores any residual value for the leased property b. The lessor ignores any residual value for the leased property c. The lessee adds the present value of the residual value to the amount recorded for the lease. d. The lessor will always charge a higher annual lease rate

b. The lessor ignores any residual value for the leased property Think about the logic behind. If it is reasonably certain that the leased asset will be transferred to the lessee at the end of the lease, then the lessor would not expect to residual value (it would belong to the lessee).

Pita Pub leased a specialty machine for a five-year non-cancelable term. At the end of the five-year term, Pita Pub has four consecutive one-year renewal options. A replacement machine can be acquired, but due to an expensive installation process and Pita Pub's lease term for its mall location, Pita Pub expects to lease the machine for seven years. What is the lease term? Select one: a. 5 years b. 6 years c. 7 years d. 9 years

c. 7 years

From the perspective of the lessee, two are two major types of leases. That is, leases may be classified as either: Select one: a. Sales-type without selling profit or sales-type with selling profit. b. Finance or sales-type without selling profit. c. Finance or operating. d. Sales-type or operating.

c. Finance or operating.

Distinguishing between operating and finance leases is due in large part to the accounting concept of Select one: a. Conservatism b. Materiality c. Substance over form d. Historical cost

c. Substance over form In form, all lease agreements are rental arrangements. One party (the lessor) owns legal title to property while the other (the lessee) rents the use of that property for a specified period of time. However, in substance, a lease agreement may go beyond a pure rental agreement. Financial accounting has long held that a fairly presented portrait of an entity's financial operations and economic health is only achieved by looking past the form of a transaction to report the actual substance of what is taking place. "Substance over form" is a mantra often heard in financial accounting. Over thirty years ago, U.S. GAAP was created (by FASB) to provide authoritative guidance for the financial reporting of leases. An official pronouncement released at that time states that "a lease that transfers substantially all of the benefits and risks incident to the ownership of property should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee." In simple terms, this standard means that a lessee can obtain such a significant stake in leased property that the transaction more resembles a purchase than it does a rental. If the transaction looks like a purchase, the accounting should be that of a purchase. When the transaction is more like a purchase, it is recorded as a capital lease. When the transaction is more like a rental, it is recorded as an operating lease.

Which of the following is a correct statement of one of the classification tests? Select one: a. The lease transfers ownership of the property to the lessor. b. The lease contains a purchase option. c. The lease term is equal to or more than 75% of the estimated economic life of the leased property. d. The lease payments equal or exceed 90% of the fair value of the leased property.

c. The lease term is equal to or more than 75% of the estimated economic life of the leased property.

In a operating lease, the amortization of the right-of-use asset in the third year is: Select one: a. the same as in the fourth year. b. zero c. less than in the fourth year d. more than in the fourth year.

c. less than in the fourth year Please refer to the notes to see why under operating leases, the amortization should be greater each year as time passes.

At the beginning of a finance lease, a guaranteed residual value should be: Select one: a. Excluded from the calculation of lease payments. b. Included as part of the calculation of lease payments at present value. c. Included as part of the calculation of lease payments at future value. d. Included as part of lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.

d. Included as part of lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual 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. If a potential future payment is expected (that is, the expected residual value is less than the guaranteed residual value), it must be included in the calculation of the present value of the lessee's future lease payments. The guidelines for accounting for a guaranteed residual value are as follows: • If it is probable that the expected residual value is equal to or greater than the guaranteed residual value, the lessee should not include the guaranteed residual value in the computation of the lease liability. • If it is probable that the expected residual value is less than the guaranteed residual value, the difference between the expected and guaranteed residual values should be included in computation of the lease liability.

Additional lease adjustments that affect the measurement of lease assets and liabilities include each of the following except? Select one: a. executory costs b. initial direct costs c. lease prepayments and incentives d. internal costs

d. internal costs