CH 21 STUDY GUIDE

look at questions 9-11 MC

BBC

In computing the present value of the payments under the present value test, the lessee must use a discount rate. Normally, use of the lessee's incremental borrowing rate is appropriate unless: A. the lessee's incremental borrowing rate exceeds the prime interest rate on the date of the lease agreement, in which case the prime interest rate should be used. B. the incremental borrowing rate is less than two-thirds of the prime interest rate, in which case the prime interest rate should be used. C. the lessee knows the implicit rate of the lessor. D. the lessee's incremental borrowing rate is double the LIBOR rate

C

A lease is a contractual agreement conveying ownership of certain property from one part to another party.

FALSE: A lease is a contractual agreement conveying the rights to use property from one to another. A lease does not by definition transfer ownership. Such arrangements can be written into a lease agreement, but the transfer of ownership is not a part of all lease agreements.

Under an operating lease, the lessor generally records a Lease Receivable and eliminates the leased asset.

FALSE: Under a sales-type lease, the lessor generally records a Lease Receivable and eliminates the leased asset. Under an operating lease, the lessor generally continues to recognize the asset on its balance sheet and recognized lease revenue in each period.

Lease prepayments made by the lessee decrease the right-of-use asset.

FALSE: Lease prepayments made by the lessee increase the right-of-use asset.

When determining the present value test, the incremental borrowing rate is generally a more realistic rate to use in determining the amount to report as the asset and related liability.

FALSE: When determining the present value test, the implicit rate is generally a more realistic rate to use in determining the amount to report as the asset and related liability.

An advantage of leasing for the lessee is protection against obsolescence.

TRUE

Executory costs included in the fixed payments required by the lessor should be included in lease payments for purposes of measuring the lease liability.

TRUE

For classification purposes, a lessee includes the full amount of a residual value guarantee at the end of the lease term in the present value test.

TRUE

If a lease contains a bargain purchase option, the lessee shall classify and account for the arrangement as a finance lease.

TRUE

The lease classification tests for the lessor are identical to the tests used by the lessee to determine classification of a lease as a financing or operating lease.

TRUE

When a lease is classified as an operating lease, the lessee continues to report a separate interest expense.

FALSE: When a lease is classified as an operating lease, the lessee does not report a separate interest expense, instead the lessee reports interest on the lease liability as part of Lease Expense.

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

If a lease arrangement meets a sales-type lease, but payments by the lessee are determined as not probable, then A. the lessor records the lease as an operating lease. B. the lessor records the lease as a finance lease but makes a disclosure as to the improbability of payments. C. the lessor does not record a receivable and does not derecognize the leased asset, but instead records any receipt of lease payments as a deposit liability. D. the lessor records the lease as a finance lease at the amount determined to be collected as probable.

C

Which of the following lease arrangements would most likely be accounted for as an operating lease by the lessee? A. The lease agreement runs 16 years and the economic life of the lease property is 20 years. B. The present value of the minimum lease payments is $55,600 and the fair value of the leased property is $60,000. C. The lease agreement allows the lessee the right to purchase the leased asset for $1.00 when half of the asset's economic useful life has expired. D. The lessee may renew the two-year lease for an additional two years at the same rental.

D

Initial direct costs incurred by the lessee are included in the cost of the lease liability but are not recorded as part of the right-of-use asset.

FALSE: Initial direct costs incurred by the lessee are included in the cost of the right-ofuse asset but are not recorded as part of the lease liability.

The FASB uses 75% as the guideline to determine if the present value of the lease payments is reasonably close to the fair value of the asset under the present value test.

FALSE: The FASB uses 90% as the guideline to determine if the present value of the lease payments is reasonably close to the fair value of the asset under the present value test.

In a direct financing lease, the lessor recognizes the profit at the commencement of the lease.

FALSE: In a direct financing lease, the profit is deferred and recognized over the life of the lease.

A bargain purchase option affects the accounting for leases in the same way as a guaranteed residual value with a probable amount to be owed.

TRUE

Wilson Company has a machine with a cost of $250,000 which also is its fair market value on the date the machine is leased to Berger Company. The lease is for 6 years and the machine is estimated to have a residual value of zero. If the lessor's implicit interest rate is 6%, the six beginning-of-the-year lease payments would be: A. $47,962.92 B. $50,840.70 C. $55,639.51 D. $60,223.43

A

A lessee does not include an unguaranteed residual value in the computation of the lease liability, whether it is a finance lease or an operating lease.

TRUE

Which of the following is not one of the commonly discussed advantages of lease for the lessor? A. The lessor has the right of first priority to use the leased asset since the lessor is still the owner of the asset. B. It often provides profitable interest margins. C. It can provide a high residual value to the lessor upon return of the property at the end of the lease term. D. It often provides tax benefits to various parties in the lease.

A

Which of the following lease arrangements would most likely be accounted for as a finance lease by the lessee? A. The lessee rents the truck for $1,000 a month for 10 years and after 10 years has an option to continue renting the truck for an additional 10 years at $50 per month, and the estimated life of the truck is 15 years. B. At the end of the lease term, the lessor has another use for the asset that was specially created for the lessee. C. The present value of the minimum lease payments is $32,000 and the fair value of the lease property is $40,000. D. The lease agreement runs 5 years and the economic life of the lease property is 10 years.

A

There are different views on the capitalization of leases. Which of the following has been adopted by the FASB? A. Capitalize firm leases where the penalty for nonperformance is substantial. B. Capitalize all long-term leases. C. Do not capitalize any leased assets. D. Capitalize leases that a similar to installment purchases.

B

Which of the following is not one of the commonly discussed advantages of leasing for the lessee? A. Leasing permits 100% financing at fixed rates. B. Leasing permits changes in equipment more easily thus reducing the risk of obsolescence. C. Leasing improves financial ratios by increasing assets without a corresponding increase in debt. D. Lease agreements may contain less restrictive provisions than other debt agreements.

C

If it is probable that the expected residual value is less than the guaranteed residual value, the lessee should not include the guaranteed residual value in the computation of the leased liability.

FALSE: If it is probable that the expected residual value is less than the guaranteed residual value, the difference between the expected and guaranteed residual values should be included in computation of the lease liability. If it is probable that the expected residual value is equal to or greater than the guaranteed residual value, the lessee should not include the guaranteed residual value in the computation of the leased liability.

In an operating lease, the lessee recognizes interest expense on the lease liability over the life of the lease using the effective-interest method and records the amortization expense on the right-of-use asset generally on a straight-line basis.

FALSE: In 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 the amortization expense on the right-of-use asset generally on a straight-line basis. 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 lease expense is the same from period to period.

Regardless of whether a lease is short-term or long-term, a lessee has to record a right-of-use asset and a lease liability.

FALSE: When there is a short-term lease, rather than recording a right-of-use asset and lease liability, lessees may elect to expense the lease payments as incurred.

When valuing the lease liability the lessee should estimate increases or decreases to future lease payments based on variable payments that change based on increases or decreases in an index or rate.

FALSE: The lessee should include variable lease payments in the value of the lease liability at the level of the index/rate at the commencement date. When valuing the lease liability, no increases or decreases to future lease payments should be assumed based on increases or decreases in the index or rate. Instead, any difference in the payments due to changes in the index or rate is expensed in the period incurred.

For leases classified as operating, the lessee records a right-of-use asset and lease liability at commencement of the lease, similar to the finance lease approach.

TRUE

In a sale-leaseback arrangement, a company (the seller-lessee) transfers an asset to another company (the buyer-lessor) and then leases that asset back from the buyer-lessor.

TRUE

Initial direct costs are incremental costs of a lease that would not have been incurred had the lease been executed.

TRUE

The FASB has adopted the approach that all long-term leases should be capitalized.

TRUE

Under a sale-leaseback, if the lessor continues to control the asset, it should not record a sale nor recognize a gain or loss.

TRUE

When the lease term is a major part of the remaining economic life of the leased asset, companies should use the finance method in accounting for the lease transaction.

TRUE