Deck 18: Accounting for Leases

Question 1

What is meant by the agency cost of leasing?

Answer 1

The user who controls the asset during the lease (the lessee)is not the owner of the asset (because the lessor still owns it).The lessor must bear a risk that the lessee will not take the utmost care of the leased property (or as much care as the lessor would).This reduced level of care due to separation of an asset's ownership and its control is the agency cost of leasing.

Question 2

Identify whether the following characteristics/facts are relevant to a finance (capital)lease.

Answer 2

Question 3

List factors that impact the degree to which this agency cost is a factor.

Answer 3

a)The inherent nature of the asset that is leased.Assets that are robust and difficult to damage have lower agency costs and are better candidates for leasing.
b)The incentives of the lessee to maintain the condition of the leased asset.Some types of lessees are more motivated to maintain the leased asset than others.For example,airlines are very keen to ensure that their leased aircraft are safe for their customers since the consequences of equipment failure are severe in terms of both the airlines' business and human lives.
c)Regulations that require a high degree of care.Airlines again are a good example here.Regulators have stringent requirements for maintaining commercial passenger aircraft.
d)Conditions negotiated between the lessor and lessee.Lease agreements often contain conditions that mitigate agency costs.For example,damage deposits for apartments,mileage limits for cars,bargain purchase options and guaranteed residual values.
e)The length of the lease contract.If the length of the lease contract covers substantially the entire useful life of the asset then agency costs will be minimal,since the lessee bears the cost of neglecting or abusing the property.

Question 4

Which statement is correct?

A)In a finance lease,the lessee uses the asset for only a short fraction of the asset's useful life.
B)The lessee expenses the cost of the lease in the period the benefits are received in a finance lease.
C)A finance lease transfers the risks and rewards from the lessee to the lessor.
D)In a finance lease,the lessee records an asset for the property being used.

Question 5

What is the general criterion for deciding whether a lease is an operating or a finance lease?

Question 6

The following are the characteristics of a lease:

Required:
Determine the present value of minimum lease payments (MLP)and the appropriate classification of this lease for the lessee.

Question 7

What are four examples of lease conditions that help mitigate agency costs?

Question 8

Which statement is correct respecting the criteria for determining whether a lease is an operating or a finance lease?

A)Substantially all of the risks and rewards of ownership have been transferred from the lessee to the lessor.
B)There is a transfer of ownership to the lessee or a bargain purchase option (BPO)at the end of the lease.
C)The lease term is a minor part of the economic life of the asset.
D)The present value of the minimum lease payments comprises substantially 50% fair value of the leased asset.

Question 9

What are the advantages to the lessee of an operating lease?

Question 10

Which statement is correct?

A)In an operating lease,the lessee uses the asset for most of the asset's useful life.
B)The lessee expenses the cost of the lease in the period the benefits are received in an operating lease.
C)An operating lease transfers the risks and rewards from the lessor to the lessee.
D)In an operating lease,the lessee records an asset for the property being used.

Question 11

Which condition would result in an operating lease?

A)Risk of breakage is with the lessee.
B)Reward of high resale value is with the lessor.
C)Risk of change in rental rates is with the lessee.
D)Reward of longer than expected useful life for the leased asset is with the lessee.

Question 12

The following are the characteristics of a lease:

Required:
Determine the present value of minimum lease payments (MLP)and the appropriate classification of this lease for the lessee.

Question 13

Which statement is correct about "agency cost of leasing"?

A)Conditions can be added to the lease agreement to increase agency costs.
B)Agency costs are nil if the lease contract covers the entire useful life of the asset.
C)Assets that are easy to damage are better candidates for leasing.
D)Assets that are difficult to damage have higher agency costs.

Question 14

List four examples of the risks and four examples of rewards of ownership.

Question 15

Which statement is correct about "agency cost of leasing"?

A)The lease payments are lowered to compensate for the agency cost of leasing.
B)Shorter lease terms decrease the agency cost of leasing.
C)Agency cost of leasing is an illustration of the "moral hazard" problem.
D)Agency cost of leasing is an illustration of the "adverse selection" problem.

Question 16

Which will increase the "agency cost of leasing"?

A)Having a bargain purchase option in the lease agreement.
B)Having maintenance requirements for the leased asset.
C)Leasing assets that are easy to damage.
D)Having a guaranteed residual value by the lessee.

Question 17

Which will decrease the "agency cost of leasing"?

A)Leased assets that are easy to damage.
B)Leased assets that require maintenance and care by the lessee.
C)Having lease terms that cover small portions of the asset's useful life.
D)Having an unguaranteed residual value by the lessee.

Question 18

The following are the characteristics of a lease:

Required:
Determine the present value of minimum lease payments (MLP)and the appropriate classification of this lease for the lessee.

Question 19

What are executory costs?

A)Maintenance costs that are applicable to only operating leases.
B)Maintenance costs that are incurred only when the asset is leased.
C)Maintenance costs that are incidental costs in a lease that would be incurred by the lessee independent of whether the lessee had purchased or leased the asset.
D)Maintenance costs that are applicable to only finance leases.

Question 20

The following are the characteristics of a lease:

Required:
Determine the present value of minimum lease payments (MLP)and the appropriate classification of this lease for the lessee.

Question 21

On January 1,2017,Travic Company entered a lease to rent office space.The lease requires Travic to pay $390,000 per year,at the end of each year,for 20 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 30 years,and its current fair value is estimated to be $6 million.Travic's incremental borrowing rate is 10%.
Required:
Classify this lease for Travic Company and record the journal entries for the first year of the lease.

Question 22

On July 1,2017,Janus Company leased equipment to Pluto Company.The terms of the lease are as follows:

Pluto uses straight-line depreciation for its property,plant,and equipment,and its year-end is December 31.
Required:
Prepare the journal entries for the lease from July 1 through December 31.

Question 23

What is the meaning of "minimum lease payments"?

A)Payments over the lease term including executory costs.
B)Payments over the lease term excluding executory costs.
C)Payments over the lease term until the bargain purchase option is exercised.
D)Payments over the lease term until guaranteed residual value is received.

Question 24

Which factor would contribute toward the lessor classifying a lease as a financial lease?

A)Lessor retains risk of breakage to leased asset.
B)Lessor has reward of high resale value.
C)Lessor does not have risk of change in demand for the leased asset.
D)Lessor does not have guaranteed residual value.

Question 25

On January 1,2017,Rushabh Company entered a lease to rent office space.The lease requires Rushabh to pay $190,000 per year,at the end of each year,for 10 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 30 years,and its current fair value is estimated to be $6 million.Rushabh's incremental borrowing rate is 9%.
Required:
Classify this lease for Rushabh Company and record the journal entries for the first year of the lease.

Question 26

Which entry is needed by the lessee for an operating lease?

A)Recording of interest expense.
B)Recording of the lease obligation.
C)Recording of rental expense.
D)Recording of depreciation expense.

Question 27

What entry is required for the lessor in a operating lease?

A)Gain/loss on asset sale.
B)Loan receivable.
C)Interest income.
D)Depreciation expense.

Question 28

The following are characteristics of a lease:

Required:
Determine the appropriate classification for this lease for the lessor (who is not the manufacturer)and record the journal entries for the lessor for the first year of the lease.

Question 29

Chambers leased equipment to Montga Company on November 1,2016.The terms of the lease are as follows:

Montga uses straight-line depreciation for its property,plant,and equipment.
Required:
a.Prepare the journal entries for the lease from November 1 through December 31,2016.
b.You and the director of finance for Montga Company.You are concerned about the impact the lease will have on your key performance indicator,the total debt to total assets ratio.Discuss the impact the lease will have on this performance indicator.

Question 30

What entry is required for the lessor in a finance lease?

A)Loan receivable.
B)Rental income.
C)Interest expense.
D)Depreciation expense.

Question 31

Channel leased equipment to Montage Company on November 1,2016.The terms of the lease are as follows:

Montage uses straight-line depreciation for its property,plant,and equipment.
Required:
Prepare the journal entries for the lease from November 1 through December 31,2016.

Question 32

The following are characteristics of a lease:

Required:
Determine the appropriate classification for this lease for the lessor (who is not the manufacturer)and record the journal entries for the lessor for the first year of the lease.

Question 33

On July 1,2016,Jupiter Company leased equipment to Planet Company.The terms of the lease are as follows:

Planet uses straight-line depreciation for its property,plant,and equipment,and its year -end is December 31.
Required:
Prepare the journal entries for the lease from July 1 through December 31,2016.

Question 34

On January 1,2017,Troy Company entered a lease to rent office space.The lease requires Troy to pay $190,000 per year,at the beginning of each year,for 10 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 30 years,and its current fair value is estimated to be $6 million.Troy's incremental borrowing rate is 9%.
Required:
Classify this lease for Troy Company and record the journal entries for the first year of the lease.

Question 35

On January 1,2017,Brownee Company entered a lease to rent office space.The lease requires $350,000 per year,at the end of each year,for 20 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 40 years,and its current fair value is estimated to be $6 million.The incremental borrowing rate is 5%.
Required:
Classify this lease and record the journal entries for the first year of the lease.

Question 36

On January 1,2017,Granite Company entered a lease to rent office space.The lease requires $350,000 per year,at the beginning of each year,for 20 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 30 years,and its current fair value is estimated to be $6 million.The incremental borrowing rate is 5%.
Required:
Classify this lease and record the journal entries for the first year of the lease.

Question 37

The following are characteristics of a lease:

Required:
Determine the appropriate classification for this lease for the lessor (who is not the manufacturer)and record the journal entries for the lessor for the first year of the lease.

Question 38

On January 1,2017,Pelvisee Company entered a lease to rent office space.The lease requires Pelvisee to pay $390,000 per year,at the beginning of each year,for 15 years.The lease is non-cancellable and non-renewable.The building's estimated useful life is 30 years,and its current fair value is estimated to be $6 million.Pelvisee's incremental borrowing rate is 9%.
Required:
Classify this lease for Pelvisee Company and record the journal entries for the first year of the lease.

Question 39

Which statement is correct about the "guaranteed residual value"?

A)It is assurance that the lessee will take care of the property.
B)It is provided by the lessor.
C)Lessor assumes the risk of the property falling below the guaranteed amount.
D)It is not included in the minimum lease payment calculation.

Question 40

List four major risks of ownership.

Question 41

What is the incremental borrowing rate?

A)The interest rate that the lessor would have to pay on a similar lease or loan.
B)The interest rate that the lessee would have to pay on a similar lease or loan.
C)The risk adjusted interest rate from the cash flow stream expected by the lessor.
D)The risk adjusted interest rate from the cash flow stream expected by the lessee.

Question 42

Here are the terms of a lease agreement:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.
c.Compute the present value of minimum lease payments for the lessor.
d.Evaluate whether the lessee should classify the lease as operating or finance.

Question 43

When is it possible for the present value of the minimum lease payments to exceed the fair value of the leased property.What must the lessee do to prevent recording an overvalued asset?

Question 44

Here are the terms of a lease agreement:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 45

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.
c.Compute the present value of minimum lease payments for the lessor.
d.Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE.

Question 46

Which statement is correct about the "guaranteed residual value"?

A)It is not included in the minimum lease payment calculation.
B)Lessee assumes the risk of the property falling below the guaranteed amount.
C)Lessor assumes the risk of the property falling below the guaranteed amount.
D)It is an executory cost in the lease arrangement.

Question 47

Here are the terms of a lease agreement:

Required:
Determine the amount of lease payment that the lessor would require to lease the asset.

Question 48

Which statement is true?

A)The guaranteed residual value is provided by the lessor.
B)The bargain purchase option is not a part of the minimum lease payment calculation.
C)The incremental borrowing rate is the interest rate that the lessor would have to pay on a similar lease or loan.
D)One of the risks of ownership is the risk of obsolescence.

Question 49

What is true respecting the economics behind leasing arrangements?

A)By agreeing to provide a guarantee that the leased property will be worth at least a certain amount,the lessor assures the lessee that the property will be treated with due care.
B)A guaranteed residual value means that the lessee bears the risk and cost of the property falling below the specified value of the guarantee.
C)Since the lessor is assured of receiving the guaranteed amount (or more),the guaranteed residual value does not form part of the minimum lease payment.
D)The bargain purchase option (BPO)is not part of the minimum lease payment even though a BPO is almost certain to be exercised.

Question 50

Here are the terms of a lease agreement:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.
c.Compute the present value of minimum lease payments for the lessor.
d.Evaluate whether the lessee should classify the lease as operating or finance.

Question 51

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.
c.Compute the present value of minimum lease payments for the lessor.
d.Evaluate whether the lessee should classify the lease as operating or finance.

Question 52

Here are the terms of a lease agreement:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 53

Give three examples in which the lessor could use to manipulate estimates and how the wording of the accounting standards anticipate and compensate for this tendency toward manipulation.

Question 54

Why do lessors prefer financing lease treatment over operating lease treatment?

Question 55

Why do the supporting indicators for lease classification use "major part" and "sub- stantially all" rather than "all" in reference to the amount of time and value contained in the lease?

Question 56

Salisbury Creamery leases its ice cream making equipment from Little Rock Finance Company under the following lease terms:
∙ The lease term is five years,non-cancellable,and requires equal rental payments of $56,926 due at the beginning of each year starting January 1,2016.
∙ Upon inception of the lease on January 1,2016,Little Rock purchased the equipment at its fair value of $280,000 and immediately transferred it to Salisbury Creamery.The equipment has an estimated economic life of five years,and a $20,000 residual value that is guaranteed by Salisbury Creamery.
∙ The lease contains no renewal options,and the equipment reverts to Little Rock Finance Company upon termination of the lease.
∙ Salisbury's incremental borrowing rate is 4%;the rate implicit in the lease is also 4%.
∙ Salisbury depreciates similar equipment that it owns on a straight-line basis.
∙ Both companies have December 31 year-ends.
Required:
a.Evaluate how the lessee should account for the lease transaction.
b.Evaluate how the lessor should account for the lease transaction.
c.Prepare the lessee's amortization schedule for this lease.
d.Prepare the journal entries on January 1,2016 for both parties.
e.Prepare the journal entries on December 31,2016 and January 1,2017 for both parties.

Question 57

Which statement is correct about the bargain purchase option (BPO)?

A)It is cash that the lessee will receive at the end of the lease.
B)It cannot be assumed that the BPO will be exercised.
C)It is excluded in the minimum lease payment calculation.
D)It means that it is almost certain that ownership will transfer to the lessee.

Question 58

Here are the terms of a lease agreement:

Required:
Determine the amount of lease payment that the lessor would require to lease the asset.

Question 59

Zarlon Leasing Company agrees on January 1,2017 to rent Killington Winery the equipment that Killington requires to expand its production capacity to meet customers' demands for its products.The lease agreement calls for five annual lease payments of $11 0,000 at the end of each year.Killington has identified this as a finance lease.Furthermore,the company has determined that the present value of the lease payments,discounted at 4%,is $489,700.The leased equipment has an estimated useful life of five years and no residual value.Killington uses the straight-line method for depreciating similar equipment that it owns.
Required:
a.Prepare a lease amortization schedule for this lease.
b.Prepare the necessary journal entries for the first year of the lease.

Question 60

Discuss what is meant by the risk-adjusted rate and which risk adjusted rates the lessee and the lessor should use?

Question 61

Here are the terms of a lease agreement:

Required:
Determine the amount of lease payment that the lessor would require to lease the asset.

Question 62

Under ASPE,assuming all information is available,which rate is used by the lessee in the lease present value calculations?

A)Implicit borrowing rate.
B)Lessee's incremental borrowing rate.
C)Lower of the incremental and implicit rate.
D)Either the incremental or implicit rate.

Question 63

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 64

For the following lease,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 22,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & 15,000 \\\hline\end{array}$$

A)83,397
B)92,711
C)98,048
D)102,304

Question 65

For the following lease,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 23,104 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & \mathrm { NA } \\\hline \text { Guaranteed residual value } & 20,000 \\\hline\end{array}$$

A)99,053
B)100,001
C)105,859
D)106,210

Question 66

For the following lease,determine the minimum present value calculation for the lessor.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 23,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (known to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & \mathrm { NA } \\\hline \text { Guaranteed residual value } & 25,000 \\\hline\end{array}$$

A)91,832
B)102,711
C)105,444
D)108,846

Question 67

For the following lease,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 23,104 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & \mathrm { NA } \\\hline \text { Guaranteed residual value } & 20,000 \\\hline\end{array}$$

A)75,164
B)78,636
C)100,001
D)105,859

Question 68

Which statement is correct for the lessee?

A)If the minimum lease payments exceed fair value of the leased asset,the asset will be recorded on the balance sheet at the higher amount.
B)If the minimum lease payments exceed fair value of the leased asset,the asset will be recorded on the balance sheet at the fair value amount.
C)If the minimum lease payments are lower that the fair value of the leased asset,the asset will be recorded on the balance sheet at the unguaranteed residual value amount.
D)If the minimum lease payments are lower that the fair value of the leased asset,the implicit rate must be used.

Question 69

Which statement is correct for the lessee?

A)Using the higher of the incremental or implicit rate maximizes the present value of the minimum lease payment calculation.
B)Using the lower of the incremental or implicit rate maximizes the present value of the minimum lease payment calculation.
C)Using the incremental rate maximizes the minimum lease payment calculation.
D)Using the implicit rate maximizes the minimum lease payment calculation.

Question 70

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.
c.Compute the present value of minimum lease payments for the lessor.
d.Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE.

Question 71

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 72

Under IFRS,assuming all information is available,which rate is used by the lessee in the minimum lease calculation?

A)Implicit borrowing rate.
B)Lessee's incremental borrowing rate.
C)Lower of the incremental and implicit rate.
D)Either the incremental or implicit rate.

Question 73

For the following lease,determine the minimum present value calculation for the lessor.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 30,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & 28,000 \\\hline\end{array}$$

A)113,723
B)119,781
C)131,109
D)138,838

Question 74

The following are some of the characteristics of an asset available for lease:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 75

For the following lease,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 30,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Guaranteed residual value } & 28,000 \\\hline\end{array}$$

A)113,723
B)119,781
C)131,109
D)138,838

Question 76

For the following lease,under IFRS,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 23,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (known to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & \mathrm { NA } \\\hline \text { Guaranteed residual value } & 20,000 \\\hline\end{array}$$

A)99,607
B)102,711
C)105,444
D)108,847

Question 77

Here are the terms of a lease agreement:

Required:
a.Determine the amount of lease payment that the lessor would require to lease the asset.
b.Compute the present value of minimum lease payments for the lessee.

Question 78

What is the implicit rate?

A)The interest rate that the lessor would have to pay on a similar lease or loan.
B)The interest rate that the lessee would have to pay on a similar lease or loan.
C)The risk adjusted interest rate from the cash flow stream expected by the lessor.
D)The risk adjusted interest rate from the cash flow stream expected by the lessee.

Question 79

For the following lease,determine the minimum present value calculation for the lessor.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 22,000 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 10 \% \\\hline \text { Implicit rate (unknown to lessee) } & 8 \% \\\hline \text { Unguaranteed residual value } & 15,000 \\\hline\end{array}$$

A)83,400
B)92,711
C)98,048
D)102,304

Question 80

For the following lease,under IFRS,determine the minimum present value calculation for the lessee.
$$\begin{array} { | l | l | } \hline \text { Annual payment (due at end of year) } & \$ 23,150 \\\hline \text { Lease term } & 5 \\\hline \text { Incremental rate } & 8 \% \\\hline \text { Implicit rate (known to lessee) } & 6 \% \\\hline \text { Guaranteed residual value } & 10,000 \\\hline\end{array}$$

A)92,431
B)97,516
C)99,237
D)104,989