WILEY CH 21-22

Which type of accounting change should always be accounted for in current and future periods? Change in accounting estimate Change in reporting entity Correction of an error Change in accounting principle

Change in accounting estimate

Which of the following is not one of the three types of accounting changes? Change in accounting estimate. Correction of an error. Change in accounting principle. Change in reporting entity.

Correction of an error.

Which of the following is not one of the three types of accounting changes? Change from LIFO to FIFO. Change in reporting entity. Correction of understated depreciation expense in a prior period . Change in the estimated useful life of an asset.

Correction of understated depreciation expense in a prior period .

A lease that involves a manufacturer's or dealer's profit is a(an): (a)direct financing lease. (b)finance lease. (c)operating lease. (d)sales-type lease.

D

Under IFRS, 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)use the implicit rate of the lessor, unless it is impracticable to determine the implicit rate.

D

Which of the following is true regarding whether IFRS specifically addresses the accounting and reporting for effects of changes in accounting policies? Direct effects Indirect effects (a) Yes Yes (b) No No (c) No Yes (d) Yes No

D

Which of the following statements is true when comparing the accounting for leasing transactions under GAAP with IFRS? (a)IFRS for leases is more "rules-based" than GAAP and includes many bright-line criteria to determine ownership. (b)IFRS requires that companies provide a year-by-year breakout of future non-cancelable lease payments due in years 1 through 5. (c)The IFRS leasing standard is the subject of over 30 interpretations since its issuance in 1982. (d)IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.

D

A change in accounting principle is a change that occurs as the result of new information or additional experience. True False

F

A change in the useful life and salvage value of a depreciable asset is handled retrospectively. True False

F

In general, IFRS accounting on leases is more detailed and prescriptive than the corresponding U.S. GAAP on leases. True False

F

In a sale-leaseback transaction, if the lease includes a bargain purchase option, the seller-lessee accounts for the transaction as a sale and the lease as a capital lease, and amortizes the profit from the sale over the lease term. True False

F In a sale-leaseback transaction, if the lease includes a bargain purchase option, the seller-lessee accounts for the transaction as a sale are amortizes the profit from the sale over the economic life of the asset.

In a sale-leaseback transaction, if the lease term is 75% or more of the economic life of the asset, with no bargain purchase option or title transfer, the seller-lessee accounts for the transaction as a sale and the lease as a capital lease, and amortizes the profit from the sale over the economic life of the asset. True False

F In a sale-leaseback transaction, if the lease term is 75% or more of the economic life of the asset , the seller-lessee accounts for the transaction as a sale and amortizes the profit from the sale over the lease term.

IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors) always requires retrospective application to prior years for accounting changes. True False

F In general, IAS 8 requires retrospective application to prior years for accounting change. However, the standard does permit the cumulative-effect method or prospective method if a company cannot reasonably determine the amounts to which to restate prior periods.

The present value of the unguaranteed residual value is excluded in the calculation of the minimum lease payments for the lessee, but included when calculating depreciation expense. True False

F The present value of only the unguaranteed residual value is excluded from both the calculation of the minimum lease payments for the lessee and depreciation expense.

T/F GAAP requires that corrections of errors be handled prospectively and shown in the current operating section of the income statement in the year the correction is made.

F corrections of errors be treated as prior period adjustments, be recorded in the year in which the error was discovered, and be reported in the financial statements as an adjustment to the beginning balance of retained earnings. If comparative statements are presented, the prior statements affected should be restated to correct for the error.

T/F If a change in an accounting estimate affects current net income by an amount equal to or greater than 1% of net income, the change should be handled retroactively.

F) Changes in accounting estimates must be handled prospectively, that is, no changes should be made in previously reported results. Opening balances are not adjusted and no attempt is made to catch-up for prior periods.

T/F The FASB requires companies to use the prospective (in the future) approach for reporting changes in accounting principles.

F) The FASB requires companies to use the retrospective approach for reporting changes in accounting principles.

Which of the following is not a counterbalancing error? Understatement of unearned revenue. Failure to record depreciation. Failure to record accrued wages. Failure to record prepaid expenses.

Failure to record depreciation.

Minimum lease payments include both a guaranteed and an unguaranteed residual value. True False

False Minimum lease payments do guaranteed residual value, but not unguaranteed residual value.

How does lease accounting under generally accepted accounting principles (GAAP) differ from lease accounting under International Financial Reporting Standards (IFRS)? GAAP uses additional criteria for the lessor such as collectability of payments and additional cost. GAAP requires the lessee to record the lease at the higher of the implicit rate and the incremental rate. GAAP requires that the total net present value of lease payments be disclosed for future years. GAAP is more general in its approach to determining whether a lease arrangement transfers reward of ownership.

GAAP uses additional criteria for the lessor such as collectability of payments and additional cost.

Is the following exception applicable to IFRS or U.S. GAAP?"If determining the effect of a correction of an error is considered impracticable, then a company should report the effect of the error correction in the period in which it believes it practicable to do so."

IFRS Y GAAP N

Is the following exception applicable to IFRS or U.S. GAAP?"If determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so."

IFRS Y GAAP Y

Which of the following statements is true when comparing the accounting for leasing transactions under U.S. GAAP with IFRS? IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases. The IFRS leasing standard is the subject of over 30 interpretations since its issuance in 1982. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5. IFRS for leases is more "rules-based" than U.S. GAAP and includes many bright-line criteria to determine ownership.

IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.

Which of the following statements regarding IFRS and U.S. GAAP accounting and reporting for changes in accounting principles is incorrect? Under U.S. GAAP and IFRS, if determining the effect of a change in accounting principle is considered impracticable, then a company should report the effect of the change in the period in which it believes it practicable to do so, which may be the current period. IFRS explicitly addresses the accounting and disclosure of indirect effects related to a change in accounting principle. While both IFRS and U.S. GAAP require restatement of previously issued financial statements for error corrections, U.S. GAAP is an absolute standard, with no exception to this rule. The FASB has issued guidance on changes in accounting principles, changes in estimates, and corrections of errors, which essentially converges U.S. GAAP to IAS 8.

IFRS explicitly addresses the accounting and disclosure of indirect effects related to a change in accounting principle.

All of the following statements about lease accounting under IFRS are true except: IFRS is more general in its lease accounting provisions than is U.S. GAAP. The IFRS leasing standard, IAS 17, is the subject of only three interpretations. The IFRS leasing standard is IAS 17, first issued in 1982. IFRS requires a year-by-year breakout of payments related to leasing arrangements.

IFRS requires a year-by-year breakout of payments related to leasing arrangements.

Which of the following statements related to changes in estimates is not correct? Financial statements of prior periods are not restated. Pro forma amounts for prior periods are reported. These changes are viewed as normal recurring corrections and adjustments. Opening balances are not adjusted for the change.

Pro forma amounts for prior periods are reported.

A change in depreciation method used is which type of accounting change? Prospective-effect type. Cumulative-effect type. Retrospective-effect type. Counterbalancing-effect type.

Prospective-effect type.

A company fails to record accrued wages for the current year. Which of the following statement is true? Retained earnings for the current year is overstated. Retained earnings for the current year is understated. Net income for the current year is understated. Net income for the current year is correct.

Retained earnings for the current year is overstated.

Which one of the following amounts would differ in a sales-type lease with an unguaranteed residual value instead of a guaranteed residual value? None of these answers are correct. Lease receivable. Gross profit. Sales price of the asset.

Sales price of the asset.

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

T

A switch from the cash basis of accounting to the accrual basis is correction of an error. True False

T

Changes due to an error result in a restatement of the beginning retained earnings balance. True False

T

Errors in financial statements result from mathematical mistakes or oversight or misuse of facts that existed when preparing the financial statements. True False

T

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 False

T

IFRS and GAAP both require the companies apply the direct effects of changes in accounting policies retrospectively. True False

T

If an FASB standard creates a new principle, expresses preference for, or rejects a specific accounting principle, the change is considered clearly acceptable. True False

T

Inventory errors are counterbalancing errors. True False

T

Recording a depreciable asset as an expense is an example of a noncounterbalancing error. True False

T

T/F A change in accounting principle results when a company changes from one GAAP to another GAAP.

T

T/F An understatement in ending inventory will result in a corresponding understatement of net income.

T

T/F Changes in estimates must be handled prospectively.

T

T/F Lease disclosure requirements on the part of the lessor apply only to lessors whose predominant business activity is leasing.

T

T/F The criteria a lessee uses to determine whether a lease is a capital lease or an operating lease apply in the case of a sale-leaseback transaction.

T

T/F The lease receivable is the present value of the minimum lease payments.

T

T/F Under a leasing arrangement, it is possible to write off the full cost of a leased asset including land and residual values.

T

T/F When a company changes an accounting principle, one of the disclosure requirements is to show the cumulative effect of the change on retained earnings as of the beginning of the earliest period presented.

T

T/F When a company makes changes that result in different reporting entities, the company should report the change by changing the financial statements of all prior periods presented and the revised statements should show the financial information for the new reporting entity for all periods.

T

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

T

Understating ending inventory will understate the current year's net income. True False

T

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 False

T

International Financial Reporting Standards (IFRS) and generally accepted accounting principles (GAAP) provide guidance for reporting accounting changes and errors. Which guideline applies only under International Financial Reporting Standards (IFRS)? The impracticality exception applies to the correction of errors. The impracticality exception applies to changes in accounting principles. The impracticality exception applies to changes in accounting principles. Companies must report indirect effects of accounting policy changes in the current period.

The impracticality exception applies to the correction of errors.

Which of the following is one of the criteria for recording a lease as a finance lease, under IFRS? The lease doesn't contain a bargain-purchase option. The present value of the minimum lease payments amounts to 75% of the fair value of the leased asset. The lease term is for the major part of the economic life of the asset. The lease must be cancelable.

The lease term is for the major part of the economic life of the asset.

Recognition of a gain or loss on the sale-leaseback transaction by the seller-lessee depends on whether or not the seller-less will continue to use the asset after the sale or gives up the right to use the asset. True False

True

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

True

Detailed guidance regarding the accounting and reporting for the indirect effects of changes in accounting principle is available under neither U.S. GAAP nor IFRS. both U.S. GAAP and IFRS. IFRS only. U.S. GAAP only.

U.S. GAAP only.

Which of the following statements is true? IFRS is more general in its provisions for determining if a lease arrangement transfers the risks and rewards of ownership. Under IFRS, in computing the present value of the minimum lease payments, the lessee is required to use the incremental borrowing rate. Operating leases under GAAP are referred to as finance leases under IFRS. IFRS has an additional lessor criterion for capitalization that collectability of the payments required from the lessee is reasonably predictable.

Under IFRS, in computing the present value of the minimum lease payments, the lessee is required to use the incremental borrowing rate.

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? Set the lease term at something less than 75% of the estimated useful life of the property. Write in a bargain purchase option. Lessee uses a higher interest rate than that used by lessor. Use a third party to guarantee the asset's residual value.

Write in a bargain purchase option.

All of the following are disclosures required of the lessor except: total contingent rentals included in income for each period for which an income statement is presented. all of these answers are correct. the components of the net investment in sales-type and direct financing leases as of each balance sheet date. future minimum lease payments to be received for each of the five succeeding years.

all of these answers are correct.

Failure to record depreciation expense in a given year must be accounted for: as a prior period adjustment. prospectively. currently. by showing pro forma data.

as a prior period adjustment.

In 2013, PWT Company failed to record depreciation expense on some of its assets. When the error is discovered in 2014, it will be accounted for: prospectively. as a prior period adjustment. all of these answer choices are correct. using pro forma data.

as a prior period adjustment.

A change that occurs as the result of new information or as additional experience is acquired is a: change in reporting entity. change in accounting principle. correction of an error. change in accounting estimate.

change in accounting estimate.

When a company changes from an accelerated method to the straight-line method of depreciation, this change should be handled as a change in accounting principle. correction of an error. change in accounting estimate. prior period adjustment.

change in accounting estimate.

Whenever it is impossible to determine whether a change in principle or a change in estimate has occurred, the change should be considered a: counterbalancing error. change in estimate. correction of an error. change in principle.

change in estimate.

Accounting changes are often made and the monetary impact is reflected in the financial statements of a company even though, in theory, this may be a violation of the accounting concept of consistency. faithful representation. objectivity. materiality.

consistency.

Accounting changes are often made and the monetary impact is reflected in the financial statements of a company even though, in theory, this may be a violation of the accounting concept of materiality. objectivity. consistency. conservatism.

consistency.

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

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

All of the following involve counterbalancing errors except the understatement of inventory. overstatement of purchases. failure to record prepaid expenses. failure to adjust for bad debts.

failure to adjust for bad debts.

All of the following involve counterbalancing errors except the: failure to record prepaid expenses. failure to record depreciation. overstatement of ending inventory. understatement of purchases.

failure to record depreciation.

An example of a correction of an error in previously issued financial statements is a change in the service life of plant assets, based on changes in the economic environment. from the cash basis of accounting to the accrual basis of accounting. in the tax assessment related to a prior period. from the FIFO method of inventory valuation to the LIFO method.

from the cash basis of accounting to the accrual basis of accounting.

Lessees prefer to account for their leases as operating lease because: it increases their debt to total equity ratio. it increases the amount of total assets. it decreases the amount of liability reported. it decreases the income tax expense.

it decreases the amount of liability reported.

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

it is treated by the lessee as no residual value.

The methods of accounting for a lease by the lessee are operating and financing lease methods. none of these answers are correct. operating and capital lease methods. operating, sales, and capital lease methods.

operating and capital lease methods.

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

recognition of the manufacturer's or dealer's profit at (or loss) the inception of the lease.

The lessor expenses initial direct costs in the year of incurrence in a(n) direct financing lease and a sales-type lease. direct financing lease. operating lease. sales-type lease.

sales-type lease.

The lessor expenses initial direct costs in the year of incurrence in a(n): operating lease. sales-type lease. direct financing lease and sales-type lease. direct financing lease.

sales-type lease.

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

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

The total charges to operations over the lease term are less for a capital lease than an operating lease. greater for a capital lease than an operating lease. the same for a capital lease as an operating lease. not comparable between a capital lease and an operating lease.

the same for a capital lease as an operating lease.

Minimum lease payments are payments the lessee is obligated to make or can be expected to make in connection with the leased property. In computing minimum lease payments all of the following would be included, except the: A. present value of the cost of the leased asset. B. penalty for failure to renew or extend the lease. C. bargain purchase option. D. minimum rental payments.

6. (A) The present value of the cost of the leased asset is not a part of the specific computation of the minimum lease payments. Minimum lease payments include the items identified in alternatives B, C, and D as well as the guaranteed residual value.

All of the following statements about lease accounting under IFRS and GAAP are true except: (a)IFRS requires a year-by-year breakout of payments related to leasing arrangements. (b)IFRS is more general in its lease accounting provisions than is GAAP. (c)The IFRS leasing standard, IAS 17, is the subject of only three interpretations. (d)Finance leases under IFRS are referred to as capital leases under GAAP.

A

Which of the following is not a reason why companies prefer certain accounting methods? Bonus payments. Asset structure. Political costs. Smooth earnings.

Asset structure.

All of the following are disclosures required of the lessor except All of these answer choices are correct. The payments to be received for each of the five succeeding years. Amounts receivable and unearned revenues under lease agreements. The amount of lease revenues reported each period.

All of these answer choices are correct.

T/F Leasebacks in which the present value of the rental payments are 20% or less of the fair market value of the asset are defined as minor leasebacks and the transaction is considered a sale.

(F) Leasebacks in which the present value of the rental payments are 10% or less of the fair market value of the asset are defined as minor leasebacks. Minor leasebacks are not considered financing transactions and the transaction is considered a sale (with full gain or loss recognition).

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) A lease is a contractual agreement between a lessor and a lessee that conveys to the lessee the right to use specific property (real or personal), owned by the lessor, for a specific period of time in return for stipulated and generally periodic cash payments. An essential element of the lease agreement is that the lessor conveys less than the total interest in the property. There are no sinking fund or lease term requirements that must be met for a lease to exist. Also, leased property need not be held for sale prior to the lease agreement.

Which of the following is not considered a direct effect of a change in accounting principle? A. An employee profit-sharing plan based on net income when a company uses the percentage-of-completion method. B. The inventory balance as a result of a change in the inventory valuation method. C. An impairment adjustment resulting from applying the lower-of-cost-or-market-test to the adjusted inventory balance. D. Deferred income tax effects of an impairment adjustment resulting from applying the lower-of-cost-or-market test to the adjusted inventory balance.

(A) An employee profit sharing plan based on net income when a company uses the percentage-of-completion method is considered an indirect effect of a change in accounting principle. All the other answers are considered direct effects.

In 2014 the Flynn Company has changed from the percentage-of-completion method to the completed-contract method for long-term construction contracts. The difference in pre-tax income prior to 2014 is a decrease of $60,000 and for 2014 is a decrease of $20,000. The estimated tax effect is 40%. The journal entry made by Flynn Company should include a: A. Debit to Deferred Tax Liability of $24,000. B. Credit to Deferred Tax Liability of $32,000. C. Debit to Deferred Tax Liability of $32,000. D. Credit to Deferred Tax Liability of $24,000.

(A) The change in accounting principles from percentage-of-completion method to completed-contract method for long-term construction contracts would result in a direct effect adjustment to deferred taxes. Because income decreased, there would be a 40% decrease in Deferred Tax Liability which is done with a debit entry. The amount is calculated by multiplying the difference in pre-tax income prior to 2014 by 40%.

Schoen Company experienced a change in accounting principle which it accounted for in the following manner: opening balances were not adjusted and no attempt was made to allocate charges or credits for prior events. This method of recording an accounting change is known as handling the change: A. prospectively. B. currently. C. retrospectively. D. haphazardly.

(A) The company has handled its accounting change prospectively. This method is required to be used for changes in accounting estimates. When a change is handled currently, the cumulative effect of the use of the new method on the financial statements at the beginning of the period is computed. This adjustment is then reported in the current year's income statement as an irregular item. A retrospective adjustment of the financial statements is made by recasting the financial statements of prior years on a basis consistent with the newly adopted principle and any cumulative effect of the change as an adjustment to beginning retained earnings of the earliest year presented. There is no haphazard treatment advocated for accounting changes.

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) A bargain purchase option allows the lessee to purchase the leased property for a future price that is substantially lower than the property's expected future price. If a bargain purchase option exists, the lessee must increase the present value of the minimum lease payments by the present value of the option price. The certainty of exercise at lease inception is not a necessary condition for increasing the present value of the minimum lease payments. The existence of a bargain purchase option is sufficient.

If a lease transaction is accorded capital lease treatment rather than operating lease treatment, it would have what impact on the following financial items of the lessee? Reported Total Return on Debt Assets Total Assets A. Increase Increase Increase B. Increase Increase Decrease C. Decrease Increase Increase D. Increase Increase No Effect

(B) Because the capital lease treatment records the asset and the related debt on the lessee's financial statements, these items will both increase as a result of a capital lease. However, with total assets being greater the return on assets will decrease as the leasing arrangement does not provide an additional source of revenue to the lessee.

Any gain or loss resulting from a sale-leaseback where the lease is an operating lease must be: A. taken into income on the date of the sale-leaseback agreement. B. deferred and amortized in proportion to the rental payments over the period of time the asset is expected to be used by the lessee. C. deferred and amortized in proportion to the rental payments over the economic life of the asset. D. deferred and not taken into income until the lease agreement has terminated.

(B) Profit or loss in a sale-leaseback situation should be deferred and amortized. If the lease is a capital lease the profit or loss should be deferred and amortized over the lease term in proportion to the amortization of the leased assets. In an operating lease, the profit or loss should be deferred and amortized in proportion to the rental payments over the period of time the assets are expected to be used by the lessee.

T/F The lessee records a capital lease as an asset, using the fair market value of the leased asset on the date of the lease as the asset's cost.

(F) The leased asset recorded on the books of a lessee is recorded at the lower of (a) the present value of the minimum lease payments excluding any executory cost, or (b) the fair market value of the leased asset at the inception of the lease.

T/F When a company changes an accounting principle it should not adjust any assets or liabilities.

(F) When a company changes an accounting principle it adjusts the carrying amounts of assets and liabilities as of the beginning of the first year presented.

Debbie Company leased equipment to the Trant Company on July 1, 2014, for a ten-year period expiring June 30, 2024. Equal annual payments under the lease are $50,000 and are due on July 1 of each year. The first payment was made on July 1, 2014. The rate of interest contemplated by Debbie and Trant is 9%. The cash selling price of the equipment is $350,000 and the cost of the equipment on Debbie's accounting records was $310,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Debbie, what is the amount of profit on the sale and the interest income that Debbie would record for the year ended December 31, 2014? A. $0 and $0 B. $40,000 and $13,500 C. $40,000 and $27,000 D. $40,000 and $31,500

(B) Under a sales-type lease, the amount of profit on the sale is the difference between the sales price of the asset and the cost of the asset. For Debbie Company the amount of the profit is thus $40,000 ($350,000 - $310,000). The amount of the interest income is calculated by multiplying the net investment by the effective interest rate (and then prorating to the portion of the year). In this case, the net investment at December 31, 2014, was $300,000 ($350,000 - $50,000) and the effective interest rate is 9% to obtain $27,000. However, because only a half a year has passed, only half of the $27,000, or $13,500, should be considered earned.

Which of the following is not one of the commonly discussed advantages of leasing? A. Leasing permits 100% financing versus 60 to 80% when purchasing an asset. B. Leasing permits rapid changes in equipment, thus reducing the risk of obsolescence. C. Leasing improves financial ratios by increasing assets without a corresponding increase in debt. D. Leasing permits write-off of the full cost of the asset.

(C) A lease arrangement does not improve financial ratios. When a capital lease is involved, an asset is recorded but so is a corresponding liability. This transaction will actually result in a negative impact on most ratios of the lessee.

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 interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be: A. $30,806 B. $41,667 C. $54,291 D. $60,807

(C) Fair market value of leased machine $250,000 Less present value of the residual value -0- Amount to be recovered by lessor $250,000 Six beginning-of-the-year lease payments to yield 12% return ($250,000/4.60478 = $54,291.41) (Table 6-5)

The accounting principles used in lease accounting attempt to provide symmetry between the lessee and lessor. With respect to lease rental payments in a capital lease, they are considered to consist of both interest and principal by the: Lessee Lessor A. Yes No B. No Yes C. Yes Yes D. No No

(C) The lessee and the lessor treat the lease rental payments in a capital lease as consisting of interest and principal.

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) The manner in which rental receipts are recorded, the amount of depreciation recorded, and the allocation of initial direct costs are not primary differences in applying the financing method to a direct financing lease or a sales-type lease. The primary difference is in recognition of the manufacturer's or dealer's profit at the inception of the lease.

Under the operating method, a rent expense accrues day by day to the lessee as the property is made available for use. This amount of rent expense is: A. capitalized in an asset account and charged against income as the asset depreciates. B. capitalized in an asset account and netted against the corresponding lease liability each time a balance sheet is prepared. C. charged against income in the periods benefiting from the use of the asset. D. charged against income at the same rate as the reduction in the corresponding

(C) The rent expense resulting from an operating lease is charged against income in a manner consistent with the matching concept. Thus, rent expense is charged against income in the period(s) benefiting from the use of the leased asset.

On January 1, 2014, Cihla Airlines sold an airplane to an unaffiliated company for $400,000. The airplane had a book value of $360,000 and a remaining useful life of 8 years. That same day, Cihla leased back the airplane at $5,000 per month for 4 years with no option to renew the lease or repurchase the airplane. Cihla's rent expense for this airplane for the year ended December 31, 2014 should be: A. $ -0-. B. $12,000. C. $15,000. D. $60,000.

(C) This lease is an operating lease to Cihla because there is no option to renew or repurchase the airplane, the lease term of 4 years is less than 75% of the estimated life of the aircraft (8 x 75 % = 6) and the present value of the lease payments is less than 90% of the fair value of the airplane (the lease payments without calculating present value are $240,000 ($5,000 x 12 x 4), which is less than 90% of the fair value of the plane of $360,000 (90% x $400,000). Therefore, Cihla accounts for the transaction as a sale and the lease as an operating lease. The rent expense for the year is therefore $15,000 [($5,000 x 12) ÷ 4].

In a sale-leaseback transaction, the seller-lessee retains the right to substantially all of the remaining use of the equipment sold. The profit on the sale should be deferred and subsequently amortized by the lessee when the lease is classified as a(n): Capital Operating Lease Lease A. No Yes B. No No C. Yes No D. Yes Yes

(D) Any profit related to a sale-leaseback transaction in which the seller-lessee retains the right to substantially all of the remaining use of the equipment sold shall be deferred and amortized in proportion to the amortization of the leased asset, if a capital lease, or in proportion to the related gross rental charged to expense over the lease term, if an operating lease. It is important to note that losses are recognized immediately for either a capital or operating lease.

T/F When it is impossible to differentiate between a change in estimate and correction of an error, companies should consider careful estimates that later prove to be incorrect as a correction of an error.

(F) When it is impossible to differentiate between a change in estimate and correction of an error, companies should consider careful estimates that later prove to be incorrect as a change in estimate.

T/F When the lessor accounts for minimum lease payments, the basis for capitalization includes the guaranteed residual value but excludes the unguaranteed residual value.

(F) When the lessor accounts for the minimum lease payments, the lessor works on the assumption that the residual value will be realized at the end of the lease term whether guaranteed or unguaranteed.

The general rule for differentiating between a change in an estimate and a correction of an error is: A. based on the materiality of the amounts involved. Material items are handled as a correction of an error, whereas immaterial amounts are considered a change in an estimate. B. if a generally accepted accounting principle is involved, it's usually a change in an estimate. C. if a generally accepted accounting principle is involved, it's usually a correction of an error. D. a careful estimate that later proves to be incorrect should be considered a change in an estimate.

(D) Distinguishing between a change in an estimate and a correction of an error is not necessarily determined by a GAAP being involved. Also, materiality is not one of the criteria to be used in differentiating between a change in an estimate and a correction of an error. The best basis for differentiating between a change in one estimate and a correction of an error is to follow the general rule that "careful estimates that later prove to be incorrect should be considered a change in an estimate."

If the lease term is equal to 75% or more of the estimated economic life of the leased property, the asset should be capitalized by the lessee. The one exception to this rule is when: A. the lease term is for 5 years or less. B. the lessee does not intend to exercise its option to purchase the asset at the conclusion of the lease term. C. the lessor refuses to offer a bargain purchase option and the leased property will revert to the lessor at the end of the lease term. D. the inception of the lease occurs during the last 25% of the life of the asset.

(D) The FASB takes the position that if the inception of the lease occurs during the last 25% of the life of the asset, the economic life test cannot be used as a basis to classify a lease as a capital lease. The length of the lease is not a consideration, nor is the intent to exercise any bargain purchase option. Even if the leased property is to revert to the lessor, the economic life test is invalid as long as the asset is in the last 25% of its economic life.

The December 31, 2014, physical inventory of Dunn Company appropriately included $4,500 of merchandise inventory that was not recorded as a purchase until January, 2015. What effect will this error have on the following account balances at 12/31/14? Retained COGS Liabilities Earnings Assets A. Overstate Overstate Understate Understate B. No Effect Understate Understate Understate C. Understate No Effect Overstate Overstate D. Understate Understate Overstate No Effect

(D) The merchandise was correctly counted in the physical inventory and thus ending inventory and total assets are properly stated. The fact that the purchase was not recorded understates liabilities because accounts payable was not credited. Also, with the purchase not being recorded, the amount of merchandise available for sale is understated and results in an understatement of cost of goods sold. The understatement of cost of goods sold causes both net income and retained earnings to be overstated.

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) The residual value is the estimated fair market value of a leased asset at the end of the lease term. A guaranteed residual value occurs when a lessee or another third party agrees to make up any deficiency below a stated amount that the lessor realizes at the end of the lease term. If the residual value is guaranteed by a third party, it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.

In addition to the four criteria that a lessee must assess in deciding whether to classify a lease transaction as a capital lease, a lessor must meet two additional criteria. These include (1) the collectibility of the payments required from the lessee is reasonably predictable, and (2): A. the lease includes an element of manufacturer or dealer profit. B. the lessee has the ability to meet the requirements of the guaranteed residual value. C. executory costs are provided for in a manner which makes their ultimate payment virtually a certainty. D. no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.

(D) The two additional requirements for the lessor to account for a lease as a capital lease are there to be sure that the lessor has really transferred the risks and rewards of ownership. If collectibility of payments is not predictable or if performance by the lessor is incomplete, then it is inappropriate to remove the leased asset from the lessor's books and accounting for the lease as an operating lease is more appropriate.

T/F When the lessee accounts for a capital lease, the amortization (depreciation) of the asset and the discharge of the lease obligation should be handled in a consistent manner over the same number of accounting periods.

(F) Although the amount capitalized as an asset and the amount recorded as an obligation at the inception of the lease are computed at the same present value, the amortization of the asset and the discharge of the obligation are independent accounting processes during the term of the lease. They need not be written off over the same number of accounting periods.

T/F Any profit or loss experienced by the seller-lessee in a sale-leaseback transaction must be included in income at the date of the lease agreement.

(F) Any profit or loss experienced by the seller-lessee from the sale of the assets that are leased back under a capital lease should be deferred and amortized over the lease term in proportion to the amortization of the leased asset.

T/F If an investor's level of influence has changed requiring the investor to change from the equity method to the fair value method, a retroactive adjustment is necessary.

(F) If an investor's level of influence has changed requiring the investor to change from the equity method to the fair value method, the earnings or losses that were previously recognized by the investor under the equity method should remain as part of the carrying amount of the investment with no retroactive restatement to the new method.

T/F If the previously used accounting principle was not acceptable, a change to a generally accepted accounting principle is considered a change in principle.

(F) If the previously used accounting principle was not acceptable, a change to a generally accepted accounting principle is considered a correction of an error.

Under IFRS, the retrospective approach should not be used if: (a)retrospective application requires assumptions about management's intent in a prior period. (b)the company does not have trained staff to perform the analysis. (c)the effects of the change have counterbalanced. (d)the effects of the change have not counterbalanced.

A

Which of the following is false? (a)GAAP and IFRS have the same absolute standard regarding the reporting of error corrections in previously issued financial statements. (b)The accounting for changes in estimates is similar between GAAP and IFRS. (c)Under IFRS, the impracticability exception applies both to changes in accounting principles and to the correction of errors. (d)GAAP has detailed guidance on the accounting and reporting of indirect effects; IFRS does not.

A

IFRS requires companies to use which method for reporting changes in accounting policies? (a)Cumulative effect approach. (b)Retrospective approach. (c)Prospective approach. (d)Averaging approach.

B

Which of the following is not a criterion for a lease to be recorded as a finance lease? (a)There is transfer of ownership. (b)The lease is cancelable. (c)The lease term is for the major part of the economic life of the asset. (d)There is a bargain-purchase option.

B

Which of the following is not a part of applying the current and prospective approach in accounting for a change in an estimate? A. Report current and future financial statements on a new basis. B. Restate prior period financial statements. C. Disclose in the year of change the effect on net income and earnings per share data for that period only. D. Make no adjustments to current period opening balances for purposes of catchup.

B) Restating prior period financial statements is a part of the application of the retroactive approach. That approach is not appropriate for changes in accounting estimates. Alternatives A, C, and D represent the appropriate treatment for the current and prospective approach as applied to accounting for a change in an estimate.

Which of the following is included in the minimum lease payments? Maintenance costs. Unguaranteed residual value. Executory costs. Bargain purchase option.

Bargain purchase option.

Which of the following is a reason why companies prefer certain accounting methods? Asset structure. Comparability. Asset allocation. Bonus payments.

Bonus payments.

Which of the following is not classified as an accounting change by IFRS? (a)Change in accounting policy. (b)Change in accounting estimate. (c)Errors in financial statements. (d)None of the above.

C

Which of the following is not a change in accounting principle? A. A change from completed-contracts to percentage-of-completion. B. A change from FIFO to average cost. C. Using a different method of depreciation for new plant assets. D. A change from LIFO to FIFO for inventory valuation.

C) When a company uses a different method of depreciation for new plant assets, this is not considered a change in accounting principle. A, B, and D are all considered changes in accounting principle.