Chapter 21 Practice Test

21. Major reasons why a company may become involved in leasing to other companies is (are) a. interest revenue. b. high residual values. c. tax incentives. d. all of these.

D) All of these

22. Which of the following is an advantage of leasing? a. Off-balance-sheet financing b. Less costly financing c. 100% financing at fixed rates d. All of these

D) All of these (Rather than buying equipment outright, a company rents or leases it and then purchases it at a minimal price when the lease period ends. Choosing this option enabled a company to record only the rental cost for the equipment = off balance sheet financing)

37. Which of the following would not be included in the Lease Receivable account? a. Guaranteed residual value b. Unguaranteed residual value c. A bargain purchase option d. All would be included

D. all would be included

In computing the annual lease payments, the lessor deducts only a guaranteed residual value from the fair market value of a leased asset.

False

Lessors classify and account for all leases that don't qualify as sales-type leases as operating leases

False

35. A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the a. asset's remaining economic life. b. term of the lease. c. life of the asset or the term of the lease, whichever is shorter. d. life of the asset or the term of the lease, whichever is longer.

a. asset's remaining economic life.

43. The primary difference between a direct-financing lease and a sales-type lease is the a. manner in which rental receipts are recorded as rental income. b. amount of the depreciation recorded each year by the lessor. c. recognition of the manufacturer's or dealer's profit at the inception of the lease. d. allocation of initial direct costs by the lessor to periods benefited by the lease arrangements.

c. recognition of the manufacturer's or dealer's profit at the inception of the lease.

45. For a sales-type lease, a. the sales price includes the present value of the unguaranteed residual value. b. the present value of the guaranteed residual value is deducted to determine the cost of goods sold. c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed.

c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed.

31. Executory costs include a. maintenance. b. property taxes. c. insurance. d. all of these.

d. all of these

40. If the residual value of a leased asset is guaranteed by a third party a. it is treated by the lessee as no residual value. b. the third party is also liable for any lease payments not paid by the lessee. c. the net investment to be recovered by the lessor is reduced. d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.

d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.

A lease that contains a purchase option must be capitalized by the lessee

False

Both a guaranteed and an unguaranteed residual value affect the lessee's computation of amounts capitalized as a leased asset.

False

The distinction between a direct financing lease and a sales type lease is the presence or absence of a transfer of title.

False

The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.

False

The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed.

False

Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.

False

A capitalized leased asset is always depreciated over the term of the lease by the lessee.

False When a bargain purchase, depreciate over economic life

A lessee records interest expense in both a capital lease and an operating lease.

False, only recognized on a finance lease For a finance lease, the lessee recognizes interest expense on the lease liability over the life of the lease using the effective-interest method and records amortization expense on the right-of-use asset generally on a straight-line basis. A lessee therefore reports both interest expense and amortization of the right-of-use asset on the income statement. As a result, the total expense for the lease transaction is generally higher in the earlier years of the lease arrangement under a finance lease arrangement. In an operating lease, the lessee also measures interest expense using the effective-interest method. However, the lessee amortizes the right-of-use asset such that the total reported lease expense is the same from period to period. In other words, for operating leases, only a single lease expense (comprised of interest on the liability and amortization of the right-of-use asset) is recognized on the income statement, typically on a straight-line basis. Illustrations of both these approaches are shown in the following sections.

29. Which of the following is a correct statement of one of the capitalization criteria? 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 minimum lease payments (excluding executory costs) equal or exceed 90% of the fair value of the leased property.

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

A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.

True

Companies must periodically review the estimated unguaranteed residual value in a sales type lease.

True

Direct-financing leases are in substance the financing of an asset purchase by the lessee.

True

From the lessee's viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments.

True

The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.

True

The primary difference between a direct-financing lease and a sales-type lease is the manufacturer's or dealer's gross profit.

True

When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value, that stated amount is the guaranteed residual value.

True

The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases

True The FASB has recently adopted the third approach, which requires companies to capitalize all long-term leases. The only exception to capitalization is that leases covering a term of less than one year do not have to be capitalized. The FASB indicates that the right to use property under the terms of the lease is an asset, and the lessee's commitment to make payments under the lease is a liability

Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.

True Executory costs are normal expenses associated with owning a leased asset, such as property insurance and property taxes. The accounting for executory costs depends on how the lease is structured, that is, whether the lease is a gross lease or a net lease. In a gross lease, the payments to the lessor are fixed as part of the rental payments in the contract. In a net lease, the lessee makes variable payments to a third party or to the lessor directly for the executory costs. Note that including executory costs in the measurement of the lease liability and related right-of-use asset may lead to inflated values on the balance sheet in comparison to lessees who do not capitalize these costs. Thus, the way parties structure the payment of executory costs (i.e., variable or fixed) can have potentially material implications with regard to the values that appear on the balance sheet. In summary, executory costs included in the fixed payments required by the lessor should be included in lease payments for purposes of measuring the lease liability. Payments by the lessee made directly to the taxing authority or insurance provider are considered variable payments and are expensed as incurred

36. Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor? 1. Transfers Ownership by end of lease? 2. Contains Bargain purchase option? 3. Collectibility of Lease Payments Assured? 4. Any important uncertainties? a. No Yes Yes No b. Yes No No No c. Yes No No Yes d. No Yes Yes Yes

a. No, yes, yes, no

33. In computing depreciation of a leased asset, the lessee should subtract a. a guaranteed residual value and depreciate over the term of the lease. b. an unguaranteed residual value and depreciate over the term of the lease. c. a guaranteed residual value and depreciate over the life of the asset. d. an unguaranteed residual value and depreciate over the life of the asset.

a. a guaranteed residual value and depreciate over the term of the lease.

41. When lessors account for residual values related to leased assets, they a. always include the residual value because they always assume 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. All of the above are true with regard to lessors and residual values.

a. always include the residual value because they always assume the residual value will be realized.

25. An essential element of a lease conveyance is that the a. lessor conveys less than his or her total interest in the property. b. lessee provides a sinking fund equal to one year's lease payments. c. property that is the subject of the lease agreement must be held for sale by the lessor prior to the drafting of the lease agreement. d.term of the lease is substantially equal to the economic life of the leased property

a. lessor conveys less than his or her total interest in the property.

28. The methods of accounting for a lease by the lessee are a. operating and capital lease methods. b. operating, sales, and capital lease methods. c. operating and leveraged lease methods. d. none of these.

a. operating and capital lease methods.

38. In a lease that is appropriately recorded as a direct-financing lease by the lessor, unearned income a. should be amortized over the period of the lease using the effective interest method. b. should be amortized over the period of the lease using the straight-line method. c. does not arise. d. should be recognized at the lease's expiration.

a. should be amortized over the period of the lease using the effective interest method.

23. Which of the following best describes current practice in accounting for leases? a. Leases are not capitalized. b. Leases similar to installment purchases are capitalized. c. All long-term leases are capitalized. d. All leases are capitalized.

b. Leases similar to installment purchases are capitalized.

48. To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal? a. Lessee uses a higher interest rate than that used by lessor. b. Set the lease term at something less than 75% of the estimated useful life of the property. c. Write in a bargain purchase option. d. Use a third party to guarantee the asset's residual value.

c. Write in a bargain purchase option.

32. In computing the present value of the minimum lease payments, the lessee should a. use its incremental borrowing rate in all cases. b. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee. c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. d. none of these.

c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee.

46. Which of the following statements is correct? a. In a direct-financing lease, initial direct costs are added to the net investment in the lease. b. In a sales-type lease, initial direct costs are expensed in the year of incurrence. c. For operating leases, initial direct costs are deferred and allocated over the lease term. d. All of these.

d. all of these

30. Minimum lease payments may include a a. penalty for failure to renew. b. bargain purchase option. c. guaranteed residual value. d. any of these.

d. any of these

Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of residual value to the lessor

True

26. What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee? a. No impact as the option does not enter into the transaction until the end of the lease term. b. The lessee must increase the present value of the minimum lease payments by the present value of the option price. c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price. d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.

b. The lessee must increase the present value of the minimum lease payments by the

44. A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts? a. The minimum lease payments plus the unguaranteed residual value. b. The present value of the minimum lease payments. c. The cost of the asset to the lessor, less the present value of any unguaranteed residual value. d. The present value of the minimum lease payments plus the present value of the unguaranteed residual value.

b. The present value of the minimum lease payments.

34. In the earlier years of a lease, from the lessee's perspective, the use of the a. capital method will enable the lessee to report higher income, compared to the operating method. b. capital method will cause debt to increase, compared to the operating method. c. operating method will cause income to decrease, compared to the capital method. d. operating method will cause debt to increase, compared to the capital method.

b. capital method will cause debt to increase, compared to the operating method.

27. The amount to be recorded as the cost of an asset under capital lease is equal to the a. present value of the minimum lease payments. b. present value of the minimum lease payments or the fair value of the asset, whichever is lower. c. present value of the minimum lease payments plus the present value of any unguaranteed residual value. d. carrying value of the asset on the lessor's books.

b. present value of the minimum lease payments or the fair value of the asset, whichever is lower.

24. While only certain leases are currently accounted for as a sale or purchase, there is theoretic justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that a. all leases are generally for the economic life of the property and the residual value of the property at the end of the lease is minimal. b. at the end of the lease the property usually can be purchased by the lessee. c. a lease reflects the purchase or sale of a quantifiable right to the use of property. d. during the life of the lease the lessee can effectively treat the property as if it were owned by the lessee.

c. a lease reflects the purchase or sale of a quantifiable right to the use of property.

42. The initial direct costs of leasing a. are generally borne by the lessee. b. include incremental costs related to internal activities of leasing, and internal costs related to costs paid to external third parties for originating a lease arrangement. c. are expensed in the period of the sale under a sales-type lease. d.All of the above are true with regard to the initial direct costs of leasing

c. are expensed in the period of the sale under a sales-type lease.

47. The Lease Liability account should be disclosed as a. all current liabilities. b. all noncurrent liabilities. c. current portions in current liabilities and the remainder in noncurrent liabilities. d. deferred credits.

c. current portions in current liabilities and the remainder in noncurrent liabilities.

39. In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as a. the amount of funds the lessor has tied up in the asset which is the subject of the direct-financing lease. b. the difference between the lease payments receivable and the fair market value of the leased property. c. the present value of minimum lease payments. d. the total book value of the asset less any accumulated depreciation recorded by the lessor prior to the lease agreement.

c. the present value of minimum lease payments.