Chapter 15 - Leases

Norma Manufacturing Company leases an asset to Maren Inc in a sales-type lease. The present value of the lease payments is $200,000 and the cost of the leased asset is $160,000. At the beginning of the four-year lease term, Norma should recognize a profit of:

$40,000

Samuel Company leased equipment from Lease Corp. The cost of the equipment to Lease Corp was $300,000. Lease Corp will require Samuel to make the first payment on the day of the lease signing (January 1 of Year 1), with the next four payments due on January 1 of Years 2 - 5. At the end of Year 5, the equipment is expected to have a residual value, present value being $50,000. The estimated useful life of the equipment is seven years. If the five lease payments are of an equal amount, what payment amount provides Lease Corp with a return of 6%?

$55,990 Reason: $300,000 - 50,000 = $250,000/4.46511 = $55,990

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

In which of the following ways can a lease be accounted for? (Select all that apply.)

- As a rental agreement. - As a purchase/sale agreement with debt financing.

Which of the following are criteria for classification as a finance lease? (Select all that apply.)

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

The lease term includes

- any periods covered by options to extend with significant incentive. - the contractual term of the lease.

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

- future payments for total remaining years - description of the leasing arrangements - future payments in each of the next 5 years

Which of the following are required disclosures related to leases?

- residual values - nonlease payments - variable lease cost

Smith leases a piece of equipment from Marvin Company. The lease has a bargain purchase option which is expected to be exercised at the end of the lease. The useful life of the equipment is 10 years and the lease term is 8 years. Which number of years should be used to compute amortization?

10

A reasonable conclusion is that the "major part" of the leased asset's life is included in the lease, if _____ of the remaining economic life of the asset is covered by the lease term.

75% or more

Which of the following is true regarding how a lessor reports cash flows from a sales-type lease?

Cash receipts are reported as cash inflows from operating activities.

Lease Corp leases equipment to Samuel Company in a sales-type lease. The present value of the lease payments is $250,000. The lease includes an unguaranteed residual value with a present value of $50,000. The rate implicit in the contract is 6% and the lease term is five years. Which of the following are included in the journal entry for Lease Corp to record this lease?

Credit equipment $300,000 Reason: Lease receivable (PV of lease payments) $250,000 + Residual asset (PV of $50,000 residual value)= $300,000

Sales-type lease with no selling profit

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

Operating lease

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

True or false: The incremental borrowing rate is the rate of return that the lessor desires to earn and is used to calculate the lease payments.

False Reason: The implicit rate is the desired rate of return of the lessor.

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.

In which type of lease does the lessee report interest expense and amortization expense separately in the income statement?

Finance

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

Finance lease

Which of the following are included in the lease payments used in present value calculations?

In-substance fixed lease payments

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The annual rental payment is $100,000; the first payment is due on January 1, 20X1. At the commencement of the lease, Franz should debit

Lease receivable for $431,213

Which of the following would justify reassessment of a lease term?

Leasehold improvements

Credit Inventory

Lessor's cost of equipment

Debit cost of goods sold

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

How is lease expense recorded by the lessee in an operating lease?

On a straight-line basis

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

On a straight-line basis

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an interest rate of 8% for these types of transactions. The annual rental payment is $100,000; the first payment is due on January 1, 20X1. At the commencement of the lease, Tucker should debit

Right-of-use asset for $431,213

Credit sales revenue

Sales less the PV of the residual value

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.

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

The lessee lease payments are lower.

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.

Who is the initial owner of the asset in a sale-leaseback transaction?

The lessee.

True or false: When a bargain purchase option exists, a renewal option is considered irrelevant because it is assumed that the purchase option will be exercised.

True Reason: In a bargain purchase option, it is assumed that the lessee will purchase the asset at the end of the lease term. Thus, any renewal option would not be exercised.

When is a nonlease component of a lease agreement recorded separately from the lease payments?

When the amount represents transfer of a good or service to the lessee.

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.

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, Ludwig Corporation should record

a lease receivable.

For an operating lease, the lessee will report

a single lease expense.

If future lease payments are uncertain, they are considered as part of present value calculations only if they

are in-substance fixed payments

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

are not

When the lessee is given the option of purchasing the leased property at a price significantly lower than its fair value, a _____ is present.

bargain purchase option

The most likely motivation for a sale-leaseback transaction is to generate _____.

cash

On January 1, 20X1, Mitchell Company leases equipment from Donelson Corp. for the equipments entire useful life of six years. Donelson acquired the asset for $239,826 and normally utilizes an 5% interest rate for these types of transactions. The annual lease payment is $45,000. Mitchell should recognize the first lease payment on January 1, 20X1 by

debiting lease payable for $45,000.

An advanced payment on an operating lease should be classified by the lessor as

deferred rent revenue.

Sales revenue for the lessor ________ the expected residual value to be recovered.

does not include

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

If a leased asset is specialized and has no alternative use to the lessor, then the lessee accounts for it as a(n) _____ lease.

finance or financing

The ______ is a commitment by the lessee that the lessor will recover a specified residual value when the asset is returned to the lessor.

guaranteed residual value

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.

The accounting for finance leases is similar to the purchase of an asset using an _____ note.

installment

After the first lease payment, each lease payment in a finance lease consists of an amount representing

interest and a reduction in the principal

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

irrelevant

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

A lease is classified as a finance lease by the lessee and a sales-type lease by the lessor if the present value of _____ constitutes "substantially all" of the fair value of the asset.

lease payments including any lessee-guaranteed residual value

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

A contract in which an owner provides a user the right to use an asset in return for periodic cash payments over a period of time is called a(n)

lease.

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

less than or equal to twelve months

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

The _____ should recognize amortization of the right-of-use asset.

lessee

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

lessor

Lease payments are often _____ than installment payments.

lower, less, smaller, or cheaper

The short-cut method of accounting for leases

may be used if the lease has a lease term (including any options to renew or extend) of twelve months or less.

A lease in which the rights and responsibilities of ownership are retained by the lessor is called a(n) _____ lease.

operating

Selma leases equipment from ABC Corp. The 4-year lease requires payments of $10,000 per year, beginning at the inception of the lease. The fair value of the equipment at the inception of the lease is $100,000. The equipment has a 6-year life. Selma's incremental borrowing rate is 6%. The lease does not transfer title and does not have a bargain purchase option. How should the lease be classified by Selma?

operating

The two basic lease classifications by a lessee are

operating and finance.

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

pattern or manner

The lessor's gross investment in the lease is the total of periodic rental payments

plus any residual value.

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

present value of the lease payments

A _____ is a lease provision giving the lessee the option to buy the leased property at the end of the lease term at a specified exercise price.

purchase option

The residual value of a leased asset _______ the amount the lessor needs to recover through periodic lease payments from the lessee.

reduces

The residual value of a leased asset _______ the amount the lessor needs to recover through periodic lease payments.

reduces

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

reduction in principal only

Lease accounting guidance suggests that a "major part" of the leased asset's life is 75% or more of the

remaining economic life.

When an owner of an asset sells it and immediately rents it from the new owner, the transaction is called a

sale-leaseback.

When the lessor calculates the periodic lease payments, the present value of the bargain purchase option should be

subtracted from the amount to be recovered through periodic rental payments.

An operating lease is defined as a lease:

that does not meet any of the criteria of a finance or sales-type lease.

Residual value is an estimate of

the commercial value of an asset at the end of the lease term

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

The lessee records the right-of-use asset as

the present value of lease payments.

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

the useful life of the asset.

If a bargain purchase option is expected to be exercised, the lease term ends

when the option becomes exercisable.

Munchin Manufacturing Company leases an asset to Peter Inc in a sales-type lease. The present value of the lease payments is $400,000 and the cost of the asset is $330,000. At the beginning of the five-year lease term, Munchin should recognize a profit of:

$70,000

In its income statement, what two amounts does the lessee combine into a single lease expense amount reported as a straight-line amount each period when accounting for an operating lease?

- Amortization expense - Interest expense

Fit Company leases building space from Lease Corp. Fit Company agrees to pay Lease Corp an additional amount if Lease Corp attracts a higher amount of traffic through the doors resulting in more profit for Fit Company. How are these variable lease payments treated? (Select all that apply.)

- Fit Company records lease expense when the variable lease payment is paid - Lease Corp records lease revenue when the variable lease payment is received

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, (Select all that apply)

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

Which of the following are possible reasons for leasing an asset rather than purchasing an asset? (Select all that apply)

- No additional fees - Tax benefits - Avoiding the risk of decreasing selling prices - Lower periodic payments on the asset

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 three years, and to change the amount of lease payments. The additional three years were not originally an option. How should Taylor address this lease modification? (Select all that apply)

- Reclassify from an operating lease to a finance lease - Update the right-of-use asset for the increase in present value

Which of the following occur in a sale-leaseback transaction?

- The lessee receives cash from the sale of the asset. - The lessee pays periodic rental payments.

Initial direct costs include (Select all that apply)

- costs associated with completing the lease agreement - costs that would not have been incurred if the lease agreement did not exist - costs necessary to acquire the lease

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:

- credit equipment $150,000 - credit sales revenue $223,255 - 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

Lease Corp leases equipment to Western Company in a sales-type lease. The present value of the lease payments is $450,000. The lease includes an unguaranteed residual value with a present value of $50,000. Which of the following complete the journal entry for Lease Corp to record this lease?

- credit equipment $500,000 - debit lease receivable $500,000

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? (Select all that apply)

- credit lease payable for $200,000 - debit right-of-use asset for $200,000

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The annual lease payment is $100,000. Tucker should recognize the first lease payment on January 1, 20X1 by (Select all that apply)

- crediting cash for $100,000 - debiting lease payable for $100,000

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 (Select all that apply)

- crediting cash for $100,000 - debiting lease payable for $100,000

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? (Select all that apply)

- debit accumulated depreciation for $142,857 - credit sales revenue for $300,000 - credit asset $500,000 - debit lease receivable for $300,000 - debit cost of goods sold for $357,143

North Company leased equipment from Lease Corp in a finance/sales-type lease. The annual payments equal $105,000. Payments include $5,000 which Lease Corp will use to pay the annual maintenance fee on the equipment. How should Lease Corp record the first payment? (Select all that apply)

- debit cash $105,000 - credit lease receivable $100,000 - credit maintenance fee payable $5,000

North Company leased equipment from Lease Corp in a finance/sales-type lease. The annual payments equal $105,000. Payments include $5,000 which Lease Corp will use to pay the annual maintenance fee on the equipment. How should North Company record the first payment? (Select all that apply)

- debit lease payable $100,000 - credit cash $105,000 - debit maintenance expense $5,000

Sarah Company leases a machine with a fair value of $200,000 from Eden Inc. The present value of the future lease payments is $120,000. At the inception of the lease, Sarah should (Select all that apply.)

- debit right-of-use asset for $120,000 - credit lease payable for $120,000

A purchase option: (Select all that apply)

- includes a specified exercise price. - gives the lessee the option to purchase the asset during the lease term or at the end of the lease.

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 second lease payment by debiting (round to the nearest whole dollar and select all that apply)

- interest expense for $20,617 - lease payable for $79,383

If a leased asset is of a very specialized nature and has no alternative use to the lessor at the end of the lease term, (Select all that apply.)

- it is accounted for as a finance lease. - only the lessee receives the risks and rewards of ownership.

The present value of a residual asset in a lease

- provides a source of recovery of the lessor's investment regardless of guarantee - reduces the lessee's lease payments regardless of guarantee

The most common reasons for a sale-leaseback transaction are to

- refinance at a lower rate. - generate cash.

The lessee's payment in an operating lease is

- reported as a single lease expense. - allocated between interest expense and amortization for the right-of-use asset.

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

- residual value - periodic lease payments

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:

- sales revenue for $320,000 - equipment for $200,000

A reasonable conclusion is that _____ of the fair value of the asset amounts to "substantially all" of the fair value.

90% or more

_____ _____ is an estimate of a leased asset's commercial value at the end of the lease term. (Enter only one word per blank.)

Blank 1: Residual or Salvage Blank 2: Value

The _____ residual value is a commitment by the lessee that the lessor will recover a specified residual value at the end of the lease term. (Enter one word per blank)

Blank 1: guaranteed

In a finance lease, the lessee reports the interest portion of the payment as a cash outflow from _____ activities, and it reports the portion representing principal repayment as a cash outflow from _____ activities.

Blank 1: operating Blank 2: financing or finance

A lessee makes improvements to leased property. At the end of the lease the property reverts back to the lessor. How should the costs of the improvements be classified?

Capitalize and amortize over asset useful life to the lessee.

How does the bargain purchase option affect the calculation of the amount to be recovered through periodic rental payments for the lessor?

Decreases Reason: The present value of the exercise price is deducted from the amount to be recovered

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The annual rental payment is $100,000; the first payment is due on January 1, 20X1. At the commencement of the lease, Franz should credit:

Equipment for $431,213

Sales-type lease with selling profit

Expensed at the beginning of the lease

On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an interest rate of 8% for these types of transactions. The annual rental payment is $100,000; the first payment is due on January 1, 20X1. At the commencement of the lease, Tucker should credit

Lease payable for $431,213

Debit lease receivable

PV of lease payments plus the PV of the residual value

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

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.

Initial direct costs incurred by the lessee are

added to the right-of-use asset.

The lessor's receipt of payment on an operating lease is

all recorded as lease revenue.

Periods covered by renewal options

are not included in the lease term if a bargain purchase option is present.

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

as a rental or a purchase/sale.

The present value of the residual value is ______ in/from the lease receivable, and it is ______ in/from sales and cost of goods sold for the lessor.

included; excluded

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

initial direct costs.

A lease that is more true to the nature of a rental agreement is called a(n) _____ lease.

operating

For a sales-type lease, the lessor should report cash received on the lease as a(n) ______ activity.

operating

In a(n) _____ lease, recording lease expense should reflect straight line rental of the asset during the lease term.

operating

In which section of the statement of cash flows should a lessee report payments on an operating lease?

operating

In which section of the statement of cash flows should a lessor report the receipt of payments on an operating lease?

operating

If a lease modification substantially lengthens the amount of time the lessee has the right to use an asset, it is possible that the lessee might need to switch its lease classification from _____ to _____.

operating; finance

In a finance lease, the lessee records the interest portion of payments as a cash outflow from _____ activities, and the principal portion as a cash outflow from _____ activities on the Statement of Cash Flows.

operating; financing

Under the shortcut method, the lessee recognizes

rent expense over the lease term

The journal entry to record the lessee's payment on a short-term lease under the shortcut method will include a debit to

rent expense.

An advanced payment on an operating lease is allocated to _____ over the lease term by the lessor.

rent revenue