Intermediate Accounting III Exam Review

Which of the following would a lessor not record in connection with a lease? Multiple Choice Lease revenue. Lease receivable. Interest revenue. Right-of-use asset.

Right-of-use asset. Explanation The lessee, not the lessor records a right-of-use asset.

Universal Leasing Corp. leases farm equipment to its customers. Typically the equipment has no residual value at the end of leases and the contracts call for payments at the beginning of each year. Universal's target rate of return is 10%. On a five-year lease of equipment with a fair value of $485,100, Universal will earn interest revenue over the life of the lease of: Multiple Choice $96,575 $114,900 $121,275 $194,040

$96,575 Explanation: The present value factor for an annuity due for 5 periods at 10% is 4.16987. Thus the annual payment is $116,334 ($485,100 / 4.16987), and the total receipts are $581,675 ($116,334 × 5). The interest revenue is total receipts minus fair value ($581,675 - 485,100).

Using straight-line depreciation for financial reporting purposes and MACRS for tax purposes creates: Multiple Choice A temporary difference requiring intraperiod tax allocation. A permanent difference not requiring interperiod tax allocation. A deferred tax asset. A deferred tax liability.

A deferred tax liability.

Pyramid Properties entered a lease that contains a bargain purchase option. When calculating the amount to capitalize as a right-of-use asset at the beginning of the lease term, the payment called for by the bargain purchase option should be: Multiple Choice Subtracted at its exercise price. Subtracted at its present value. Added at its present value. Excluded from the calculation.

Added at its present value. Explanation The lessee capitalizes the smaller of the present value of the lease payments or the fair value of the asset. The lease payments include both the annual payments and the amount of the exercise price of the bargain purchase option.

Which of the following leases would least likely be classified as an operating lease by the lessee? Multiple Choice The lease term is 5 years and the economic life of the leased asset is 8 years. Ownership of the leased asset reverts to the lessor at the end of the lease term. The agreement permits the lessee to buy the leased asset for one dollar at the end of the lease term. The fair value of the leased asset is $20 million and the present value of the lease payments is $13 million.

The agreement permits the lessee to buy the leased asset for one dollar at the end of the lease term. Explanation The five criteria for a lease to be categorized as a finance lease are: (1) Ownership transfers to the lessee at the end of the lease; (2) the lease contains a bargain purchase option; (3) The lease term is for the major part of the economic life of the asset; (4) the present value of the lease payments are substantially all of the fair value of the asset; (5) the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

In an operating lease in which the asset's economic life and lease term are different: Multiple Choice The lessee amortizes the leased asset over the term of the lease at a straight-line amount. The lessee amortizes the leased asset at an amount that increases each period. Correct The lessor amortizes the leased asset over the term of the lease. The lessee amortizes the asset over its economic life.

The lessee amortizes the leased asset at an amount that increases each period. Explanation In an operating lease, the lessee records a right-of-use asset and amortizes it, not on a straight-line basis, but by "plugging" the right-of-use asset amortization at whatever amount is needed to cause interest plus amortization to equal the straight-line lease payment amount. (over its economic life). Because the interest component of the straight-line lease expense decreases each period, the amortization component increases each period. In an operating lease, the lessor records no lease receivable and does not remove from its balance sheet the asset being leased.

Which of the following would a lessee not record in connection with a lease? Multiple Choice Lease revenue. Amortization expense. Interest expense. Right-of-use asset.

Lease revenue. Explanation The lessor, not the lessee records lease revenue.

When the leaseback in a sale-leaseback transaction is an operating lease, the seller-lessee: Multiple Choice immediately recognizes any gain on the sale. amortizes any gain over the lease term. recognizes any gain on the sale immediately only if the asset leased is land. does not record a gain.

immediately recognizes any gain on the sale. Explanation Since the leaseback qualifies as an operating lease, sale leaseback accounting is appropriate. Any gain on the sale is recognized immediately.

Brown Properties entered into a sale-leaseback transaction. Brown retains the right to substantially all of the remaining use of the property. A gain resulting from the sale should: Multiple Choice not be reported. be offset against losses from similar transactions. be deferred at the time of the sale-leaseback and subsequently amortized. be recognized in earnings at the time of the sale-leaseback.

not be reported. Explanation Since Brown Properties retains the right to substantially all of the remaining use of the property, economically, no sale has occurred. So, sale leaseback accounting is not permitted. Instead, the transaction is treated by both parties as a loan.

We classify a lease as a finance lease if: Multiple Choice the usual risks and rewards are retained by the lessor. the usual risks and rewards are transferred to the lessee. Correct the present value of lease payments is less than the asset's book value. the present value of lease payments is less than the asset's fair value.

the usual risks and rewards are transferred to the lessee. Explanation We have a finance lease if the lease transfers substantially all the risks and rewards of ownership of the underlying asset.

Under IFRS, a lessee will reassess variable lease payments that depend on an index or a rate: Multiple Choice only when the lessee remeasures the right-of-use asset and lease liability for other reasons. only when the lessor also reassesses the variable lease payments. whenever there is a change in the cash flows resulting from a change in the reference index or rate. Correct never.

whenever there is a change in the cash flows resulting from a change in the reference index or rate. Explanation Under IFRS, a lessee will reassess variable lease payments that depend on an index or a rate not just when the lessee remeasures the right-of-use asset and lease liability for other reasons, but also whenever there is a change in the cash flows resulting from a change in the reference index or rate.