Chapter 15

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

As a rental or a purchase/sale

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 -The lessor subtracts the present value

The accounting in which of the following parallels that of an installment purchase?

Finance 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 $421,213 -$100,000 x 4.31213 (PV of lease payments, 8%, 5 yrs)

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

sale-leaseback

An operating lease is defined as a lease

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

Operating Lease

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

Sales-Type lease with selling profit

Expensed at the beginning of the lease

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

Irrelevant

The _____ must disclose its net investment in the lease.

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

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

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

Operating

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

Debit lease receivable

PV of lease payments plus the PV of the residual value

Initial direct costs incurred by the lessee are

added to the right-of-use asset

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

initial direct costs.

An operating lease

is similar to a typical rental agreement

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

Lease payments are often ___ than installments payments

lower

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

The two basic lease classifications by a lessor are

operating and sales-type

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

reduces

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

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

-Description of the leasing arrangements -Future payments for total remaining years -Future payments in each of the next 5 years

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

-Fear of obsolescence -Insufficient cash flow -Tax benefits -Lower periodic payments on the asset

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?

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

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.

Which of the following are required disclosures related to leases?

-Variable lease cost -Nonlease payments -Residual Values

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?

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

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

90% or more

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

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

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

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

Decreases

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

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 -The implicit rate is the desired rate of return of the lessor.

True or False: The residual value of a leased asset impacts the lessee's calculation of effective interest.

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

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

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

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

Interest and a reduction in the principal

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 _______ 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 estimated commercial value of leased property at the end of the lease term is known as

Residual value

Credit sales revenue

Sales less the PV of the residual value

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

Straight-line

Which 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

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

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

The lessee

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

The lessee lease payments are lower

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

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

In an operating lease, interest expense plus amortization expense is equal to

The straight-line lease payment

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

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

are not

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

does not include

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

expected

Sometimes a lease agreement includes a commitment by the lessee that the lessor will recover a specified amount when the asset is returned. This is known as

guaranteed residual value

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

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

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

When a portion of a lease payment represents the transfer of a good or service to the lessee, it is considered a

nonlease component

If a lease does not meet any of the criteria to be classified as a finance or sales-type lease, it is classified as a(n) ___ lease.

operating

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

pattern

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 the right-of-use asset is the

present value of the leae payments

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

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

remaining economic life

The lessee records the right-of-use asset as

the present value of lease payments

The lease term includes

-Any periods covered by options to extend with significant incentive -The contractual term of the lease

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?

-Debit lease receivable $500,000 -Credit equipment $500,000

How does the bargain purchase option affect the calculation of the present value of the lease payments for the lessee?

Increases

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

lessee

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

Operating

A purchase option

-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

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,

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

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 principle repayment as a cash outflow from ____ activities.

Operating Financing

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

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

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

True or false: The exercise of a bargain purchase option is reasonably certain.

True

A bargain purchase option is a provision in a lease contract that

gives the lessee the right to purchase the leased asset at a price significantly less than the expected fair value of the property.

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

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

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

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.

guaranteed

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

Sales-type lease with no selling profit

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

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

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

-Interest Expense for $20,617 ($357,710-$100,000)x0.08 -Lease Payable for $79,383 ($100,000-$20,617)

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 -$200,000 - $160,000 = $40,000

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 -$400,000 - $330,000 = $70,000

Initial direct costs include

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

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?

-Debit Lease Payable $100,000 -Debit Maintenance Expense $5,000 -Credit Cash $105,000

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:

-Debit lease receivable $245,673 -Credit equipment $150,000 -Credit sales revenue $223,255

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 lease payable for $100,000 -Crediting cash for $100,000

Which of the following occur in a lease?

-Lessee has the right to use an asset for a specified period of time -Lessee pays the lessor periodic cash payments -Contractual agreement

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

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?

-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 would be included in the lessor's gross investment in the lease?

-Residual value -Periodic lease payments

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

-The lease included 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

At the inception of a finance lease for computer equipment, the lessee should

-debit right-of-use asset -credit lease payable

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

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 -$100,000 x 4.31213 (PV of lease payments, 8%, 5 yrs)

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

On a straight-line basis

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 in an operating lease?

Operating

On January 1, Smith Co leased equipment from Bentley Corp. The lease agreement includes four annual payments beginning at the inception of the lease. The estimated useful life of the equipment is 7 years. The lease does not contain a purchase option. The present value of the minimum lease payments is $400,000. The fair value of the asset is $500,000. What type of lease is this for Smith Co?

Operating

___ ___ is an estimate of a leased asset's commercial value at the end of the lease term.

Residual Value

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