Intermediate Chapter 21
Lease payment calculations should include
Bargain purchase options
A company has two different leases. Lease 1 has a lease term that is equal to 90% of the estimated life of the leased property, but it does not contain a bargain purchase option. In contrast, Lease 2 has a lease term that is equal to 75% of the estimated economic life of the leased property, but the ownership of the property is never transferred to the lessee. How should the company account for these leases?
Both should be classified as finance leases.
Which of the following will always be true for the lessee upon expiration of a finance lease? Select all that apply. A. The leased asset will be returned to the lessor. B. The amount capitalized will be charged to rent expense. C. The total amount paid will equal the fair value of the leased asset at the beginning of the lease. D. Most or all of the amount capitalized will be amortized. E. The accumulated amortization will equal the fair value of the leased asset at the end of the lease. F. The lease liability will be fully discharged.
D. Most or all of the amount capitalized will be amortized. F. The lease liability will be fully discharged.
Which of the following is true about a sales-type lease? A. The present value of the guaranteed residual value is deducted to determine the cost of goods sold. B. Cost of goods sold is the cost of the asset to the lessee. C. The sales price includes the present value of the unguaranteed residual value. D. The gross profit will be the same whether the residual value is guaranteed or unguaranteed.
D. The gross profit will be the same whether the residual value is guaranteed or unguaranteed.
From the lessor's point of view, any lease that is not classified a sales-type lease must be classified as a direct-financing lease.
False
The lessee's computation of the value of a right-to-use asset is affected by both a guaranteed and an unguaranteed residual value.
False
The lessor deducts only the guaranteed residual value from the fair value of a leased asset when computing annual lease payments.
False
Interest expense should be reported on the income statement by the lessee regardless of whether they have a finance lease or an operating lease.
False (only Finance)
If a lease agreement does not qualify as a finance lease, the lessee must account for the lease as a(n) ________ lease.
Operating
The estimated fair value of a leased asset at the end of the lease is the ________ value.
expected residual
For a lessee, the lease payments include
variable payments based on an index or rate.
Which of the following lease types can only be used by the lessor?
sales-type lease
Which of the following criteria must be met in order for a lease to be classified as a sales-type lease?
The collectibility of the payments from the lessee is probable.
If a lease is cancelable, the lessee cannot record it as a finance lease.
True
In order for a lease to be classified as a sales-type, the collectibility of the payments from the lessee must be probable.
True
In order for a lessor to classify a lease as a sales-type, it must involve transferring control of the right-to-use asset.
True
Under an operating lease, the lessor records each rental receipt as rental revenue.
True
From the lessor's point of view, a sales-type lease and an operating lease differ in what way?
A sales-type lease involves transfer of control of the right-of-use asset, while in an operating lease the lessee obtains the right to use the asset but not ownership of the asset.
Byers Enterprises leased machinery to Carver Manufacturing on July 1, 2019, for a ten-year period expiring June 30, 2029. The terms of the lease agreement require equal annual payments of $120,000 on July 1 of each year, starting in 2019. The effective interest rate for the lease is 9% and the present value of an annuity due of 1 for 10 periods at 9% is 6.99525 whereas the present value of an ordinary annuity of 1 for 10 periods at 9% is 6.41776. The cost of the machinery on Byers' accounting records was $820,000. If Byers properly records the lease as a sales-type lease for accounting purposes, what amount of interest revenue would Byers record for the year ended December 31, 2019?
$32,374.35 (120,000 * 6.99525) - 120,000 = 719430 719,430 * .09 * 6/12 = 32,374.35
On July 1, 2020, Athena Inc. entered into an agreement to lease machinery to Jupiter Inc. for a ten-year period. According to the terms of the lease, Jupiter must make equal annual payments of $150,000 by July 1 of each year. Jupiter paid Athena the first annual payment on the date of the lease signing. The machinery's cash selling price is $1,049,288, and Athena's accounting records indicate the cost of the machinery was $929,400. Athena's rate implicit in the lease is 9% and known by Jupiter whose incremental borrowing rate is 10%. If Athena correctly categorizes the lease as a sale-type lease, and using the following factors, it should record _______ of interest revenue for the year ended December 31, 2020. PV annuity due 10 periods, 9% 6.99525 PV annuity due 10 periods, 10% 6.75902
$40,467.96 1,049,288 - 150,000 = 899288 899288 * .09 * 6/12 = 40,467.96
On January 1, 2020, Breeden Company signed a 10-year noncancelable lease agreement to lease a storage building from Paxton Warehouse Company. The following information pertains to this lease agreement. (a) Breeden will pay equal rental payments at the beginning of each year. (b) The fair value of the building on January 1, 2020 is $4,000,000; however, the book value to Paxton is $3,300,000. (c) The building has an estimated economic life of 10 years, with no residual value. Breeden depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Breeden's incremental borrowing rate is 11% per year. Paxton Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Breeden Company. What is the amount of the annual lease payment? (Rounded to the nearest dollar.)
$591,801 PV-AD of 1 for 10 periods at 10% is 6.75902 $4,000,000/6.75902 = $591,801
Which of the following statements about lease capitalization MOST accurately reflects the FASB's preferences?
All long-term leases are capitalized.
Which of the following statements about independent lessors is TRUE? A. Independent lessors have point-of-sale access like captive leasing companies do. B. Independent lessors are starting to act as captive finance companies for companies that do not have leasing subsidiaries. C. Independent lessors have seen an increase in market share in recent years. D. Independent lessors have a higher volume of new business than either banks or captives.
B. Independent lessors are starting to act as captive finance companies for companies that do not have leasing subsidiaries.
The FASB is permitting a(n) ___ window for implementation of the new leasing standard.
Extended
Clary Instruments enters into an agreement with Fabian Industries on January 1, 2019 to lease a machine that it will use in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $287,432 are due on January 1 of each year and begin on January 1, 2019. (b) The fair value of the machine on January 1, 2019, is $800,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Clary depreciates all machinery it owns on a straight-line basis. (d) Clary's incremental borrowing rate is 10% per year. Clary does not have knowledge of the 8% implicit rate used by Fabian. What type of lease is this from Clary's viewpoint?
Finance lease
Which of the following are included in the present value of the lease payments calculation? I. Unguaranteed residual value. II. Bargain purchase option. III. Guaranteed residual value. IV. Payment option to terminate the lease that the lessee is reasonably certain to exercise.
II, III, and IV.
How is interest revenue recognized by the lessor for a sales-type lease?
It should be recognized over the period of the lease using the effective interest method.
What should the lessor generally do when a lease does not qualify as a sales-type lease?
It should classify and account for the lease as an operating lease.
What should the lessor do when a depreciable asset is leased under an operating lease?
It should record depreciation in the normal manner.
The following journal entry would be recorded by the ___for a finance lease. DR Right-of-Use Asset xxx CR Lease Liability xxx
Lessee
Which of the following incorrectly states a reason why banks, captive leasing companies, and independents typically become involved with leasing to other companies?
They can eliminate the risk of obsolescence.
Both guaranteed and unguaranteed residual values should be included in the Lease Receivable.
True
Under what circumstance would a lessee account for a lease as an operating lease?
When the lease agreement does not qualify as a finance lease
After signing a lease agreement, a company records a right-of-use asset and a liability on the balance sheet that is equal to the present value of the lease payments. What type of lease has the company signed?
a finance lease
Which of the following features of lease arrangements cause unique accounting problems?
bargain-purchase options, executory costs, initial direct costs, short-term leases
When a lease conveys use of one floor of an office building for five years it is considered a(n)
operating lease.
An operating lease conveys
right-of-use but not ownership.
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 lease liability.
A lessor recognized profit on the transfer of the leased asset and will recognize interest revenue over the life of the lease. This implies that
the lessor has recorded a sales-type lease.
The FASB concluded that by meeting any of the lease classification tests
the lessor satisfies a performance obligation.