ch 15

On January 1, 2021, Walter Scott Co. leased non-specialized machinery under a 6-year lease. The machinery has a 9-year economic life. The present value of the monthly lease payments is determined to be 80% of the machinery's fair value. The lease contract includes neither a transfer of title to Scott nor a bargain purchase option. What amount should Scott report in its 2021 income statement?

Lease expense equal to the 2021 lease payments. **This lease does not meet any of the five criteria necessary for treatment as a finance lease. Thus, the lessee amortizes the asset in the amount needed for the total lease expense (interest plus amortization) to be equal to the periodic lease payment and reports the lease payment as lease expense in its income statement.

Which of the following would a lessee not record in connection with a lease?

Lease revenue *The lessor, not the lessee accretes a residual asset.

A necessary condition for a sales-type lease is:

The lessee considers the lease to be a finance lease. **For the lessor to consider the lease a sales-type lease, one of the five classification criteria must be met. The same criteria apply for the lessee to consider a lease to be a finance lease.

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:

96,575 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).

Leasing has become the number one method of external financing by U.S. companies. Reasons include each of the following except:

Extended use of the asset. **Advantages of leasing include: Leasing reduces the upfront cash needed to use an asset. Lease payments often are lower than installment payments. Leasing offers flexibility and a lower cost when disposing of the asset. Leasing might offer protection against the risk of declining asset values. Leasing might offer tax advantages. Leasing does not extend the lessee's use of the asset beyond that of the lease term

In a ten-year finance lease, the portion of the annual lease payment in the lease's third year that represents interest is:

Less than in the second year. **The second year's lease payment comprises both interest and a reduction of the lease liability. Since interest is computed on the beginning balance of the liability account, as that balance is reduced, the interest component of subsequent payments is reduced (and the amount going to reduce the liability is increased).

If a finance lease contains a bargain purchase option, the lessee should amortize the leased asset:

Over the economic life of the asset. **If title of the asset transfers to the lessee at the end of the lease, or there is a bargain purchase option, the lessee depreciates the asset over its economic life. If neither of these are part of the finance lease agreement, the lessee depreciates the asset over the lease term.

Which of the following would a lessor not record in connection with a lease?

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

Which of the following leases would least likely be classified as an operating lease by the lessee?

The agreement permits the lessee to buy the leased asset for one dollar at the end of the lease term. **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.

Which of the following is not a sufficient criterion for a lessor to classify a lease as a sales-type lease?

The present value of the lease payments is greater than the carrying value of the leased asset. **For the lessor to consider the lease a sales-type lease, one of the five classification criteria (applicable to both the lessee and the lessor), must be met. The present value of the lease payments being greater than the carrying value of the leased asset means there is a selling profit if it's a sales-type lease.

The beginning of a six-year finance lease is December 31, 2021. The agreement specifies equal annual lease payments on December 31 of each year. For the lessee, the first payment on December 31, 2021, includes:

n an annuity due, the first payment contains no interest component - the entire payment is applied to a reduction of the lease liability.

Tucson Fruits leased farm equipment from Barr Machinery on July 1, 2021. The lease was recorded as a sales-type lease. The present value of the lease payments discounted at 10% was $40.5 million. Ten annual lease payments of $6 million are due at the beginning of each year beginning July 1, 2021. Barr had purchased the equipment for $33 million. What amount of interest revenue from the lease should Barr report in its 2021 income statement?

$1,725,000 The interest is calculated based on the fair value of the asset, which in this case is the present value of the lease payments. (If the fair value was the purchase price, then there would have been no selling profit). Thus, the 2021 interest calculation is 10% × ($40,500,000 − $6,000,000) × 6/12.

Grant Industries leased exercise equipment to Silver Gyms on July 1, 2021. Grant recorded the lease as a sales-type lease at $810,000, the present value of lease payments discounted at 10%. The lease called for ten annual lease payments of $120,000 due at the beginning of each year. The first payment was received on July 1, 2021. Grant had manufactured the equipment at a cost of $750,000. The total increase in earnings (pretax) on Grant's 2021 income statement would be:

$94,500 In 2021, there are two components to pretax earnings: interest income and selling profit. The interest income (based on the fair value of the asset) is $34,500 [10% × ($810,000 − $120,000) × 6/12], and the dealer's profit is $60,000 ($810,000 − $750,000).

Which of the following is not a sufficient criterion for a lessee to classify a lease as a finance lease?

The lease term is greater than two-thirds of the economic life of the asset. **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:

The lessee amortizes the leased asset at an amount that increases each period. ***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.