Deck 12: Accounting for Leases

Question 1

Which of the following is not a typical characteristic of a finance lease?

A) It is usually for periods up to five years
B) The lessee assumes most of the risks and benefits associated with ownership of the asset
C) It is an alternative means of financing the purchase of an asset
D) It requires a substantial 'up-front' payment by the lessee

Answer 1

D

Question 2

Leases described as 'off balance sheet' are:

A) operating leases
B) finance leases
C) in effect a secured loan
D) A and C above

Answer 2

A

Question 3

AGB Ltd has leased some equipment to Scram Ltd at an annual rental of $3000 payable at the end of the year.The equipment cost AGB $10 815 to purchase.Scram expects it will probably renew the lease each year but it does not have to do so.After five years the equipment will have no value.AGB has paid for a maintenance agreement with the makers of the equipment to cover the cost of any repairs or maintenance and has also insured it against the usual risks.AGB works on an interest rate of 12% in its calculation of lease charges and calculates any applicable depreciation on a straight-line basis.At the end of the first year,Scram decides to renew the lease for another year.At the end of that second year,AGB should make the following entry(ies):

A) $\begin{array}{l}\text { A) Dr Depreciation Expense } \quad \$ 2163\\\begin{array} { l l l } \text { Cr Accumulated Depreciation } & \$ 2163 \\\text { Dr Cash at Bank } & \$ 3000 & \\\text { Cr Lease Rental Revenue } & \$ 3000\end{array}\end{array}$
B) $\begin{array} { c c c } \text { Dr Cash at Bank } & \$ 3000 & \\\text { Cr Lease Receivable } & & \$ 1459 \\\text { Cr Interest Revenue } & & \$ 2541\end{array}$
C) $\begin{array} { c c c } \text { C) Dr Depreciation Expense } & \$ 2163 & \\ { \text { Cr Accumulated Depreciation } } & \$ 231 \\\text { Dr Cash at Bank } & \$ 3000 & \\\quad \text { Cr Lease Receivable } & \$ 1906 \\\text { Cr Lease Rental Revenue } & \$ 1093\end{array}$
D) $\begin{array} { c c c } \text { Dr Cash at Bank } & \$ 3000 & \\\text { Cr Lease Receivable } & & \$ 1906 \\\text { Cr Interest Revenue } & & \$ 1093\end{array}$

Answer 3

$\begin{array}{l}\text { A) Dr Depreciation Expense } \quad \$ 2163\\\begin{array} { l l l } \text { Cr Accumulated Depreciation } & \$ 2163 \\\text { Dr Cash at Bank } & \$ 3000 & \\\text { Cr Lease Rental Revenue } & \$ 3000\end{array}\end{array}$

Question 4

Consider the following statements concerning an instalment sale of goods:
(a)Ownership of the goods passes to the buyer when the agreement is signed
(b)It has the same legal effect as a sale by hire-purchase
(c)The seller's rights are limited to those of a creditor
(d)It is recorded as a sale when the final instalment is paid

A) Only (a) and (c) are correct
B) Only (b) and (d) are correct
C) None is correct
D) All are correct

Question 5

If a lease is non-cancellable by either party,then:

A) it can be neither a finance lease nor an operating lease
B) it may be either a finance lease or an operating lease
C) it must be an operating lease
D) it must be a finance lease

Question 6

Paragraph 15A of AASB 117 requires that when accounting for leases of land and buildings the value of the land should be:

A) treated separately for the purpose of the lease
B) never be separated from the buildings erected on the land
C) recognised as an expense in the period in which the cost was incurred
D) recognised as having a finite economic life

Question 7

Examine the following statements:
(a)Under an operating lease,substantially all the risks and benefits of ownership
Of the leased asset are transferred to the lessee
(b)A finance lease is normally non-cancellable
(c)Under a finance lease,legal ownership of the asset must be transferred
To the lessee at the end of the lease
(d)The term of an operating lease usually covers 75% or more of the
Economic life of the leased asset

A) Only (b) is correct
B) Only (a), (b) and (c) are correct
C) Only (a) and (d) are correct
D) All are correct

Question 8

Jaiko has leased equipment for 5 years at an annual rent of $4000 payable at the end of each year.Jaiko could purchase the equipment for $14 420.The implicit interest rate is 12%.At the end of the first year Jaiko should make the following entry:

A)A) Dr Lease Liability $\quad \$ 1730$
Dr Interest Expense $\quad \$ 2270$
CrCash at Bank $\quad\$ 4000$
B)B) Dr Interest Expense $\quad \$ 4000$
Cr Cash at Bank $\quad\$ 4000$
C)C) Dr Lease Liability $\quad \$ 2270$
Dr Interest Expense $\quad \$ 1730$
Dr Cash at Bank $\quad \$ 4000$
D)D) Dr Rent Expense $\quad \$4000$
Cr Cash at Bank $\quad \$4000$

Question 9

Which of the following is not a typical characteristic of an operating lease?

A) It can be used for almost any type of asset
B) It is essentially a rental agreement
C) It is similar to a leveraged lease
D) It is cancellable by the lessee at little or no cost

Question 10

Bellamy Pty Ltd enters into a sale-and-leaseback arrangement as follows:
$$\begin{array} { l l } \text { Carrying amount of asset } & \$ 50000 \\\text { Fair value of asset } & \$ 40000 \\\text { Proceeds from sale of asset } & \$ 44000\end{array}$$
The resulting lease is classified as an operating lease.According to AASB 117,Bellamy should make the following entry(ies):

A) $\begin{array} { l r } \text { A) Dr Cash at Bank } & \$ 44000 \\\text { Dr Deferred Loss on Sale } & \$ 6000 \\\text { Cr Asset } &\$50000\end{array}$
B) $\begin{array} { l r } \text { B) Dr Cash at Bank } & \$ 44000 \\\text { Dr Loss on Sale } & \$ 6000\\\text {Cr asset}&\$50000\\\end{array}$
C) $\begin{array} { l r r } \text { C) Dr Loss on Revaluation } & \$ 6000 & \\\quad \text { Cr Asset } & & \$ 6000 \\\text { Dr Cash at Bank } & \$ 44000 & \\\quad \text { Cr Asset } & & \$ 44000\end{array}$
D) $\begin{array}{l}\text { D) Dr Loss on Revaluation } \$ 10000\\\begin{array} { l r } \text { Cr Asset } & \$ 10000 \\\text { Dr Cash at Bank } & \$ 44000 \\\text { Cr Deferred gain on Sale } & \$ 4000 \\\text { Cr Asset } & \$ 40000\end{array}\end{array}$

Question 11

Fortuna Ltd has leased some machinery to be used in its business for an annual payment of $4000 due at the end of each year.The lease is non-cancellable and at the end of five years the machinery will have no value.The machinery could be purchased outright for $14 420.The rate of interest implicit in the lease agreement is 12%.At the end of the second year,Fortuna should make the following entry:

A)A) Dr Lease Liability $\$ 1458$
Dr Interest Expense $\quad \$ 2542$
Dr Cash at Bank $\quad \$ 4000$
B)Dr Interest Expense $\quad \$ 4000$
Dr Cash at Bank $\quad \$ 4000$
C)C) Dr Lease Liability $\quad \$ 2542$
Dr Interest Expense $\quad \$ 1458$
Dr Cash at Bank $\quad \$ 4000$
D) $\begin{array} { l l } \text { Dr Rent Expense } & \$ 4000 \\\text { Cr Cash at Bank } & \$ 4000\end{array}$

Question 12

Which of the following entries,shown in a company's accounting records,indicates that the company has entered into a finance lease?

Question 13

A 'sale-and-leaseback' transaction:

A) can be classified as neither a finance lease nor an operating lease
B) is always classified as a finance lease
C) can be classified as either a finance lease or an operating lease
D) is always classified as an operating lease

Question 14

Jaiko has leased equipment for 5 years at an annual rent of $4000 payable at the end of each year.Jaiko could purchase the equipment for $14 420.The implicit interest rate is 12%.What is the total amount of interest to be paid by Jaiko?

A) $5580
B) $14 420
C) $3572
D) None of the above

Question 15

AGB Ltd has leased some equipment to Scram Ltd at an annual rental of $4000 payable at the end of the year.The equipment cost AGB $14 420 to purchase.Scram expects it will probably renew the lease each year but it does not have to do so.After five years the equipment will have no value.AGB has paid for a maintenance agreement with the makers of the equipment to cover the cost of any repairs or maintenance and has also insured it against the usual risks.AGB works on an interest rate of 12% in its calculation of lease charges and calculates any applicable depreciation on a straight-line basis.At the end of the first year,AGB should make the following entry(ies):

A) $\begin{array} { l l l } \text { Dr Cash at Bank } & \$ 4000 & \\\text { Cr Lease Receivable } & & \$ 2884 \\\text { Cr Interest Revenue } & & \$ 1731\end{array}$
B)B) Dr Depreciation Expense $\quad \$ 2884$
Cr Accumulated Depreciation $\$ 2884$
Cr Cash at Bank $\quad \$ 4000$
C) $\begin{array} { c c r } \text { C) Dr Depreciation Expense } & \$ 2884 & \\{ \text { Cr Accumulated Depreciation } } & & \$ 2884 \\\text { Dr Cash at Bank } & \$ 4000 & \\\quad \text { Cr Lease Receivable } & & \$ 2269 \\\quad \text { Cr Lease Rental Revenue } & & \$ 1731\end{array}$
D) $\begin{array} { l l l } \text { Dr Cash at Bank } & \$ 4000 & \\\text { Cr Lease Receivable } & \$ 1731 \\\text { Cr Interest Revenue } & \$ 2269\end{array}$

Question 16

A typical lease agreement will always set out all of the following except:

A) who is responsible for the payment of maintenance and repair costs, insurance and taxes
B) that the lease is non-cancellable by either party
C) the amount and timing of the lease (rental) payments
D) the period of the lease

Question 17

The rental method of accounting for leases is best described as:

A) a method of accounting under which the lessee recognises assets and liabilities only from accruals or prepayments of lease rentals
B) a method of accounting under which the lessor recognises assets and liabilities only from accruals or prepayments of lease rentals
C) the method of accounting which is used to account for finance leases
D) a method of accounting under which the asset is measured as the present value of the rental payments and is shown as 'lease receivables'

Question 18

Tomfoolery Ltd enters into a sale-and-leaseback arrangement for an aircraft it owns.The resulting lease is classified as a finance lease.The details are as follows:
$$\begin{array} { l r } \text { Carrying amount of asset } & \$ 50000 \\\text { Proceeds from sale of asset } & \$ 60000 \\\text { Annual lease payment amount } & \$ 8000\end{array}$$
According to AASB 117,Tomfoolery should make which of the following entries to record the sale:

A) $\begin{array} { l l l } \text { A) Dr Cash at bank } & \$ 60000 & \\\quad \text { Cr Aircraft } & & \$ 50000 \\\quad \text { Cr Deferred gain on sale } & \$ 10000 \\\text { Dr Aircraft under lease } & \$ 60000 & \\\text { Cr Lease liability } & & \$ 60000\end{array}$
B)B) Dr Aircraft
$\$ 60000$
$\begin{array} { l l } \mathrm { Cr } \text { Cash at bank } & \$ 50000 \\ \mathrm { Cr } \text { Deferred gain on sale } & \$ 10000 \end{array}$
C) $\begin{array} { c c c } \text { C) Dr Cash at bark } & \$ 60000 & \\\quad \text { Cr Aircraft } & & \$ 50000 \\\quad \text { Cr Gain on sale income } & & \$ 10000 \\\text { Dr Aircraft under lease } & \$ 60000 & \\\quad \text { Cr Lease liability } & & \$ 60000\end{array}$
D) $\text { No entry is required as Tomfoolery will still own the asset in an economic ser }$

Question 19

Consider the following statements:
A sale-and-leaseback transaction,as far as the seller is concerned,can
(a)generate neither a profit nor a loss
(b)can generate an immediate profit but not a deferred profit
(c)can generate a deferred profit but not an immediate profit
(d)can generate an immediate loss but not a deferred loss

A) All are correct
B) Only (a) is correct
C) Only (b) and (d) are correct
D) All are incorrect

Question 20

A sale of goods under a hire-purchase agreement is usually treated by accountants as a sale when the agreement is signed because:

A) the goods are physically transferred to the buyer when the agreement is signed
B) hire-purchase agreements are usually for a 12-month term
C) accountants are more interested in the economic substance of a transaction than in its legal form
D) ownership of the goods passes to the buyer when the agreement is signed

Question 21

Managers will often have strong incentives to favour operating leases over finance leases.This is because:

A) operating leases are recorded on the balance sheet. This results in an increased debt ratio and a lower return on total assets
B) finance leases are recorded on the balance sheet. This results in a decreased debt ratio and a lower return on total assets
C) finance leases are recorded on the balance sheet. This results in an increased debt ratio and a lower return on total assets
D) None of the above. Managers do not prefer operating leases

Question 22

(a)What are the main characteristics of a sale-and-leaseback agreement and of a leveraged lease respectively?
(b)Explain the meaning and significance of the terms 'bargain purchase option' and 'guaranteed residual value' in relation to a lease agreement.

Question 23

Applefoot Ltd enters into a three year hire-purchase agreement to purchase a new motor vehicle.The financial details of the agreement are:
$$\begin{array}{l}\begin{array} { l r } \text { Cost price of car } & \$ 30000 \\\text { Deposit } & \underline { \$ 3000 } \\& \$ 33000 \\\text { Terms charges } & \underline { \$ 9000 } \\\text { Total cost of car } & \underline { \$ 2000 }\end{array}\\\text { Monthly payment } \quad \$ 1300\end{array}$$
Applefoot should record which of the following entries at the end of the first month? Note: Please assume that the interest is apportioned on a straight line basis for the purposes of this question.

A) $\begin{array} { l l } \text { Dr Lease expense } & \$ 1300 \end{array}$
$\mathrm { Cr }$ Cash at bank $\quad\$ 1300$
B)B) Dr HP liability $\quad\$ 1050$
Dr Accrued interest payable $\quad \$ 250$
Cr Cash at bank $\quad\$ 1300$
C) $\begin{array} { l r l } \text { C) Dr Interest expense } & \$ 250 \\\text { Dr Lease expense } & \$ 1050 & \\\text {Cr cash at bank} & & \$ 1300\end{array}$
D)Dr Motor vehicle (asset account) $\quad\$ 1300$
Cr Cash at bank $\quad\$ 1300$

Question 24

Discuss the implications of the proposal that operating/finance lease distinction be dropped.

Question 25

Explain the main similarities and differences between an operating lease and a finance lease,and state how each is treated in the financial statements of a business.

Question 26

How is a finance lease distinguished from an operating lease? Give an explanation of the meaning and significance of any technical terms used in your answer.