Deck 15: Leases

Question 1

At the inception of a lease agreement, the company's debt to equity ratio and rate of return on assets are both affected whether the lease is classified as a capital lease or as an operating lease.

Answer 1

False

Question 2

Of the four criteria for a capital lease, the one that most often is the decisive criteria is:

A)The 75% of economic life test.
B)The transfer of title.
C)The 90% of fair value test.
D)The bargain purchase option.

Answer 2

C

Question 3

When accounting for a capital lease, the lessee records the leased asset at the present value of the minimum lease payments or the asset's fair value, whichever is lower.

Answer 3

True

Question 4

A bargain purchase option is defined as the option of purchasing leased property at a price that is equal to the expected fair value of a leased asset.

Question 5

If the lessee is expected to take ownership of a leased asset at the end of the lease term, the lessor must use an estimated residual value when calculating the lease payments necessary to achieve a desired rate of return.

Question 6

One of the four criteria for a capital lease specifies that the present value of the minimum lease payments be equal to or greater than:

A)90% of the cost of the asset.
B)75% of the fair value of the asset.
C)90% of the fair value of the asset.
D)75% of the cost of the asset.

Question 7

In accounting for operating leases, the lessor, rather than the lessee, will recognize depreciation on the leased asset.

Question 8

Capital leases are agreements that are formulated outwardly as leases, but are installment purchases in substance.

Question 9

The four criteria provided in GAAP for distinguishing a capital lease from an operating lease do not include:

A)The agreement specifies that ownership transfers at the end of the lease term.
B)The collectibility of the lease payments must be reasonably predictable.
C)The agreement contains a bargain purchase option.
D)The noncancelable lease term is 75% or more of the useful life of the leased asset.

Question 10

For the lessee to account for a lease as a capital lease, the lease must meet:

A)All four of the criteria specified by GAAP regarding accounting for leases.
B)Any one of the six criteria specified by GAAP regarding accounting for leases.
C)Any two of the criteria specified by GAAP regarding accounting for leases.
D)Any one of the four criteria specified by GAAP regarding accounting for leases.

Question 11

One of the four criteria for a capital lease specifies that the lease term be equal to or greater than:

A)75% of the expected economic life of the leased property.
B)90% of the expected economic life of the leased property.
C)80% of the expected economic life of the leased property.
D)50% of the expected economic life of the leased property.

Question 12

When the lessee guarantees an estimated residual value of $75,000, the amount the lessee records as a leased asset and lease liability is increased by $75,000.

Question 13

When the total expenses over the life of an operating lease are compared to the total expenses over the life of a capital lease, one will find that:

A)The expenses of a capital lease are greater than the expenses of the operating lease.
B)The expenses of the capital lease and operating lease are equal.
C)The expenses of an operating lease are greater than the expenses of a capital lease.
D)No meaningful comparison can be made.

Question 14

From the perspective of the lessee, leases may be classified as either:

A)Direct financing or sales-type.
B)Capital or direct financing.
C)Capital or operating.
D)Direct financing or operating.

Question 15

Distinguishing between operating and capital leases is due in large part to the accounting concept of:

A)Conservatism.
B)Materiality.
C)Substance over form.
D)Historical cost.

Question 16

The criterion of 75% of economic life for classifying a lease as a capital lease is consistent with the basic premise that most of the risks and rewards of ownership occur during the first 75% of an asset's life.

Question 17

In addition to the criteria that must be met by the lessee, the lessor must meet additional conditions for classification as a capital lease to satisfy the realization principle.

Question 18

GAAP requires that some lease agreements be accounted for as purchases. The theoretical justification for this treatment is that a lease of this type:

A)Complies with the concept of form over substance.
B)Reflects the relationship of cause and effect.
C)Satisfies the concept of historical cost.
D)Conveys most of the risks and benefits of property ownership.

Question 19

On a sale-leaseback transaction, any gain on the "sale" portion of the transaction is recognized immediately.

Question 20

From the perspective of the lessor, leases may be classified as either:

A)Direct financing or sales-type.
B)Operating, capital, or direct financing.
C)Operating, sales-type, indirect financing.
D)Operating, direct financing, or sales-type.

Question 21

Crystal Corporation recorded a lease payment as follows: Crystal must have a(n):

A)Operating lease.
B)Leveraged lease.
C)Capital lease.
D)Direct financing lease.

Question 22

The appropriate asset value reported in the balance sheet by the lessee for an operating lease is:

A)Present value of the minimum lease payments.
B)Sum of the minimum lease payments.
C)Fair value of the asset at the inception of the lease.
D)Zero, unless a prepayment or accrual is involved.

Question 23

Of the four criteria for a capital lease, which two are not applied if the lease begins during the final quarter of the asset's useful life?

A)The 75% test and the bargain purchase option.
B)The 90% test and the 75% test.
C)The 90% test is the only one to which this applies.
D)The bargain purchase and the passage of title criteria.

Question 24

In this situation, Reagan:

A)Is the lessee in a sales-type lease.
B)Is the lessee in a capital lease.
C)Is the lessor in a capital lease.
D)Is the lessor in a sales-type lease.

Question 25

On February 1, 2013, Pearson Corporation became the lessee of equipment under a five-year, noncancelable lease. The estimated economic life of the equipment is eight years. The fair value of the equipment was $600,000. The lease does not meet the definition of a capital lease in terms of a bargain purchase option, transfer of title, or the lease term. However, Pearson must classify this as a capital lease if the present value of the minimum lease payments is at least

A)$600,000.
B)$540,000.
C)$450,000.
D)$405,000.

Question 26

Which of the following is not among the criteria for classifying a lease as a capital lease?

A)The agreement specifies that ownership of the asset transfers to the lessee.
B)The agreement contains a bargain purchase option.
C)The noncancelable lease term is equal to 90% or more of the expected economic life of the asset.
D)The present value of the minimum lease payments is equal to or greater than 90% of the fair value of the asset.

Question 27

What is the net carrying value of the lease liability in Lone Star's June 30, 2013, balance sheet? Round your answer to the nearest dollar.

A)$15,943,154.
B)$17,533,246.
C)$21,000,000.
D)None of the above is correct.

Question 28

At what amount would Reagan record the leased asset at inception of the agreement?

A)$519,115.
B)$429,115.
C)$540,000.
D)$576,000.

Question 29

What is the carrying value of the lease liability on Reagan's December 31, 2014, balance sheet (after the third lease payment is made)?

A)$280,531.
B)$190,530.
C)$266,280.
D)$356,280.

Question 30

On January 1, 2013, Gibson Corporation entered into a four-year operating lease. The payments were as follows: $20,000 for 2013, $18,000 for 2014, $16,000 for 2015, and $14,000 for 2016. What is the correct amount of lease expense for 2014?

A)$20,500.
B)$19,000.
C)$17,000.
D)$18,000.

Question 31

What is the effective annual interest rate charged to Reagan on this lease?

A)4%.
B)6%.
C)8%.
D)17%.

Question 32

Technoid would account for this as:

A)A capital lease.
B)A direct financing lease.
C)A sales-type lease.
D)An operating lease.

Question 33

Which of the following statements characterizes an operating lease?

A)The lessee records depreciation and interest.
B)The lessor records depreciation and lease revenue.
C)The lessor transfers title at the end of the lease term.
D)The lessee records a leased asset.

Question 34

If the lessor records unearned rent at the beginning of a lease term, the lease must:

A)Be a direct financing lease.
B)Be a sales-type lease.
C)Contain a bargain renewal option.
D)Be an operating lease.

Question 35

On January 1, 2013, Wellburn Corporation leased an asset from Tabitha Company. The asset originally cost Tabitha $300,000. The lease agreement is an operating lease that calls for four annual payments beginning on January 1, 2013, in the amount of $36,000. The other three remaining payments will be made on January 1 of each subsequent year. Which of the following journal entries should Tabitha record on January 1, 2013?

A)
B)
C)
D)

Question 36

Prepayments made on an operating lease are considered to be:

A)A lease expense.
B)A depreciable asset.
C)Executory costs.
D)A prepayment of rent.

Question 37

For the lessor to account for a lease as a capital lease, the lease must meet:

A)Any one of first four classification criteria and both of the last two additional conditions specified by GAAP regarding accounting for leases.
B)Any one of the six criteria specified by GAAP regarding accounting for leases.
C)All four of the criteria specified by GAAP regarding accounting for leases.
D)Any one of the four criteria specified by GAAP regarding accounting for leases.

Question 38

What is the interest revenue that Technoid would report on this lease in its 2013 income statement?

A)$0.
B)$1,673,820.
C)$876,662.
D)None of the above is correct.

Question 39

Lone Star Company would account for this as:

A)A capital lease.
B)A direct financing lease.
C)A sales type lease.
D)An operating lease.

Question 40

What is the amount of residual value guaranteed by Reagan to the lessor?

A)$1,385.
B)$34,615.
C)$36,000.
D)Cannot be determined from the given information.

Question 41

Like other assets, the cost of a leasehold improvement is allocated as depreciation expense over its useful life to the lessee, which will be:

A)The shorter of the physical life of the asset or the lease term.
B)The physical life of the asset.
C)The lease term.
D)A time period determined by management.

Question 42

Leasehold improvements usually are classified in a balance sheet as:

A)Property, plant, and equipment.
B)Other long-term assets.
C)Investments.
D)Expenses.

Question 43

What is the effective annual interest rate?

A)9%.
B)10%.
C)11%.
D)20%.

Question 44

A direct financing lease is classified in the lessor's balance sheet as:

A)An asset.
B)A liability.
C)Interest revenue.
D)A contra account to lease liability.

Question 45

The lessee normally measures the lease liability to be recorded as the:

A)Future value of the minimum lease payments.
B)Sum of the cash payments over the term of the lease.
C)Present value of the minimum lease payments.
D)Fair market value of the leased asset.

Question 46

What would be the outstanding balance after payment 10?

A)$0.
B)$2,028.
C)$8,929.
D)$10,000.

Question 47

What would the lessee record as annual depreciation on the asset using the straight-line method?

A)$5,328.
B)$6,328.
C)$6,392.
D)$10,000.

Question 48

When a lease qualifies as a capital lease, what is the cost basis of the asset acquired?

A)The present value of the minimum lease payments, exclusive of executory costs.
B)The present value of the minimum lease payments plus executory costs.
C)The sum of the gross minimum lease payments.
D)The present value of the minimum lease payments plus the present value of executory costs.

Question 49

What would the lessee record as annual depreciation on the asset using the straight-line method, assuming no residual value?

A)$3,325.
B)$6,920.
C)$4,325.
D)$5,320.

Question 50

What is the outstanding balance after payment 5?

A)$1,818.
B)$2,000.
C)$2,182.
D)$3,818.

Question 51

On September 1, 2013, Custom Shirts Inc. entered into a lease agreement appropriately classified as an operating lease. The lease term is three years. The annual payments are (a) $20,000 for year 1, (b) $24,000 for year 2, and (c) $28,000 for year 3. How much rent expense will Custom Shirts recognize for 2013?

A)$6,667.
B)$24,000.
C)$20,000.
D)$8,000.

Question 52

What is the total effective interest paid over the term of the lease?

A)$100,000.
B)$36,718.
C)$53,282.
D)$63,282.

Question 53

Since the lease payments under a lease agreement are normally paid at the beginning of each period, the appropriate compound interest table to be used to determine the amount at which the leased asset should be recorded is the:

A)Ordinary annuity table.
B)Present value of $1 table.
C)Present value of an annuity due table.
D)Future value of an annuity due table.

Question 54

For a leased asset under a lease that qualifies as a capital lease because of a bargain purchase option, the depreciation period used by the lessee must be:

A)The same period that was used by the lessor.
B)The useful life to the lessee.
C)The term of the lease regardless of the lease provisions.
D)The remaining life of the asset at the time the lease agreement took effect.

Question 55

What is the effective annual interest rate?

A)9%.
B)10%.
C)11%.
D)12%.

Question 56

For a capital lease, an amount equal to the present value of the minimum lease payments should be recorded by the lessee as a(n):

A)Asset and a liability.
B)Asset and a different amount should be recorded as a liability.
C)Liability and a different amount should be recorded as an asset.
D)Expense.

Question 57

What is the total interest paid over the term of the lease?

A)$42,000.
B)$8,200.
C)$7,400.
D)$3,460.

Question 58

If the lessor retains title to leased property under the terms of the lease:

A)The amount to be recovered through periodic lease payments is reduced by the present value of the residual amount.
B)The amount to be recovered through periodic lease payments is increased by the present value of the residual amount.
C)The amount to be recovered will be the same as if there were no residual value.
D)The lessor will record a greater amount of depreciation due to the residual value.

Question 59

What would be the amount of interest expense recorded with payment 5?

A)$2,000.
B)$893.
C)$7,107.
D)$1,107.

Question 60

What is the outstanding balance after payment 9?

A)$8,929.
B)$13,463.
C)$5,000.
D)$5,537.

Question 61

Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire that lease are called initial direct costs. Initial direct costs are expensed at the inception of the lease in:

A)An operating lease.
B)A capital lease.
C)A direct financing lease.
D)A sales-type lease.

Question 62

Which of the following statements regarding guaranteed residual values is true for the lessee?

A)The asset and liability at the inception of the lease should be increased by the amount of the residual value.
B)The asset and liability at the inception of the lease should be decreased by the amount of the residual value.
C)The asset and liability at the inception of the lease should be increased by the present value of the residual value.
D)The asset and liability at the inception of the lease should be decreased by the present value of the residual value.

Question 63

XYZ Company leased equipment to West Corporation under a lease agreement that qualifies as a capital lease to West but not as a result of a bargain purchase option or a title transfer. The present value of the asset is $600,000. The expected economic life of the asset is 10 years. The lease term is five years. Using the straight-line method, what would West record as annual depreciation?

A)$120,000.
B)$61,000.
C)$60,000.
D)$0.

Question 64

Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire that lease are called initial direct costs. Initial direct costs are recorded as assets and amortized over the term of the lease in:

A)An operating lease.
B)A capital lease.
C)A direct financing lease.
D)A sales-type lease.

Question 65

On January 1, 2013, Princess Corporation leased equipment to King Company. The lease term is eight years. The first payment of $675,000 was made on January 1, 2013. The equipment cost Princess Corporation $3,600,000. The present value of the minimum lease payments is $3,960,000. The lease is appropriately classified as a sales-type lease. Assuming the interest rate for this lease is 10%, how much interest revenue will Princess record in 2014 on this lease?

A)$261,000.
B)$328,500.
C)$325,350.
D)$293,850.

Question 66

A noncancelable lease contains a bargain purchase option. The fair value of the asset exceeds the lessor's cost of the asset. Collectibility of the lease payments is assured and there are no material cost uncertainties surrounding the lease. Therefore, the lease will be accounted for by the lessor as a(n):

A)Sales-type lease.
B)Direct financing lease.
C)Operating lease.
D)Guaranteed lease.

Question 67

The lessee's option to purchase a leased asset at a price that is sufficiently lower than the asset's expected fair value so that the exercise of the option appears reasonably assured is called a:

A)Bargain purchase option.
B)Lessee buy-out option.
C)Lessor sell-out option.
D)Guaranteed purchase option.

Question 68

If the lessee expects to obtain title to leased property due to a bargain purchase option or passage of title at the end of the lease term:

A)The lessee ignores any residual value for the leased property.
B)The lessor ignores any residual value for the leased property.
C)The lessee adds the present value of the residual value to the amount recorded for the lease.
D)The lessor will always charge a higher annual lease rate.

Question 69

Francisco leased equipment from Julio on December 31, 2013. The lease is a 10-year lease with annual payments of $150,000 due on December 31 of each year beginning December 31, 2013. The present value of the lease is $1,020,000. Francisco's incremental borrowing rate is 12% for this type of lease. The implicit rate of 10% is known by the lessee. What should be the balance in Francisco lease liability at December 31, 2014?

A)$824,400.
B)$807,000.
C)$806,400.
D)$792,000.

Question 70

Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire that lease are called initial direct costs. Initial direct costs are matched with the interest revenues they help generate in:

A)An operating lease.
B)A capital lease.
C)A direct financing lease.
D)A sales-type lease.

Question 71

What are the three types of expenses that a lessee experiences with a capital lease?

A)Lease expense, executory costs, interest expense.
B)Depreciation expense, lease expense, interest expense.
C)Executory costs, lease expense, depreciation expense.
D)Depreciation expense, interest expense, executory costs.

Question 72

On January 1, 2013, Packard Corporation leased equipment to Hewlitt Company. The lease term is eight years. The first payment of $450,000 was made on January 1, 2013. Remaining payments are made on December 31 each year, beginning with December 31, 2013. The equipment cost Packard Corporation $2,400,000. The present value of the minimum lease payments is $2,640,000. The lease is appropriately classified as a sales-type lease. Assuming the interest rate for this lease is 10%, what will be the balance reported as a liability by Hewlitt in the December 31, 2014, balance sheet?

A)$1,950,000.
B)$1,509,000.
C)$1,959,000.
D)$1,704,900.

Question 73

Recording a sales-type lease is similar to recording:

A)A purchase on account.
B)An exchange of assets.
C)A sale of a fixed asset.
D)A sale of merchandise on account.

Question 74

ABC Company leased equipment to Best Corporation under a lease agreement that qualifies as a direct financing lease. The cost of the asset is $120,000. The lease contains a bargain purchase option that is effective at the end of the fifth year. The expected economic life of the asset is 10 years. The lease term is five years. The asset is expected to have a residual value of $2,000 at the end of 10 years. Using the straight-line method, what would Best record as annual depreciation?

A)$23,600.
B)$12,200.
C)$12,000.
D)$11,800.

Question 75

If the residual value of a leased asset turns out to be more than the amount guaranteed by the lessee, the:

A)Lessor must compensate the lessee for the excess.
B)Lessee must pay the lessor the amount of the excess.
C)Lessee will reduce the last year's depreciation.
D)Lessor is not obligated to compensate the lessee for the excess.

Question 76

On January 1, 2013, Calloway Company leased a machine to Zone Corporation. The lease qualifies as a direct financing lease. Calloway paid $240,000 for the machine and is leasing it to Zone for $34,000 per year, an amount that will return 10% to Calloway. The present value of the minimum lease payments is $240,000. The lease payments are due each January 1, beginning in 2013. What is the appropriate interest entry on December 31, 2013?

A)
B)
C)
D)

Question 77

When a capital lease is first recorded at the inception of the lease, the lessee typically debits:

A)Leased asset.
B)Rent expense.
C)Lease expense.
D)Lease receivable.

Question 78

A sales-type lease differs from a direct financing lease in one respect:

A)The lessor receives a manufacturer's or dealer's profit.
B)The lessor receives more interest than on a direct financing lease.
C)The lessor receives less interest than on a direct financing lease.
D)The lessor uses a longer amortization period than on a direct financing lease.

Question 79

A guaranteed residual value at the inception of a capital lease should be:

A)Excluded from minimum lease payments.
B)Included as part of minimum lease payments at present value.
C)Included as part of minimum lease payments at future value.
D)Included as part of minimum lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.

Question 80

Additional lessor conditions for classification as a capital lease are consistent with the criteria of the:

A)Matching principle.
B)Cause and effect principle.
C)Materiality concept.
D)Realization principle.