Deck 12: Financial Reporting for Leases

Question 1

GAAP established specific criteria for the treatment of leases.One of the criteria states that the lessee must capitalize a lease if the present value of the minimum lease payments is greater than or equal to 75% of the leased asset's fair value.

Answer 1

False

Question 2

The annual expense associated with a capital lease decreases over the term of the lease.

Answer 2

True

Question 3

The lessee must depreciate a leased asset over the lease term assuming that any one of the four lease criteria applicable to the lessee are met.

Answer 3

False

Question 4

A lessee must use the incremental borrowing rate to value a capital lease.

Question 5

Executory costs of a lease are treated as operating expenses by the lessee.

Question 6

GAAP establishes specific criteria for the treatment of leases.One of the criteria states that the lessee must capitalize a lease if the lease agreement contains a bargain purchase option.

Question 7

Executory costs paid by the lessee associated with a capital lease are recorded as a component of the lease liability.

Question 8

When a company has an operating lease for its primary premises it would record a lease asset on the balance sheet.

Question 9

If a lease agreement contains a bargain purchase option,the lessee must depreciate the leased asset over the asset's useful life rather than over the lease term.

Question 10

Treating a lease as an operating lease rather than a capital lease results in an increase in the asset turnover ratio.

Question 11

GAAP establishes specific criteria for the treatment of leases.For a lessee,if any of the criteria are met,the lease must be treated as an operating lease.

Question 12

Operating leases are financial statement examples of off-balance sheet financing.

Question 13

When accounting for an operating lease,interest expense is recognized over the lease term by the lessee.

Question 14

Loan covenants are one reason lessees prefer operating lease treatment.

Question 15

When accounting for an operating lease,a liability is recognized when the lease is signed by the lessee.

Question 16

Compared to a firm with a capital lease,operating leases help the lessee firm earn a higher return on assets in the early years of the lease.

Question 17

To remain in accordance with GAAP,operating leases require note disclosure of the future cash flows arising from operating leases.

Question 18

If a lessee mistakenly treats a capital lease as an operating lease,both assets and liabilities would be understated at the inception of the lease.

Question 19

When accounting for an operating lease,depreciation expense is recorded by the lessee.

Question 20

If a lease contains a residual value guarantee,the lessee must include the guaranteed amount in the present value of the minimum lease payments.

Question 21

The current ratio will be lower over the lease term when the lessee treats the lease as a capital lease rather than an operating lease.

Question 22

For tax purposes lessees prefer operating leases.

Question 23

The lessor's Gross investment in leased asset balance is the same at the end of the lease term whether the residual value is guaranteed or unguaranteed.

Question 24

The lessor does not have any asset recorded in its financial statements for a lease classified as a sales-type lease.

Question 25

The manufacturer's or dealer's profit earned by the lessor is the same whether the residual value is guaranteed or unguaranteed.

Question 26

For a lessor using the operating lease method of recording a lease,the net effect on income is recognized evenly throughout the term of the lease,if the lessor uses straight-line depreciation.

Question 27

A lessee will record a leased asset at the lower of the present value of the minimum lease payments or the leased asset's fair value when the lease is a capital lease.

Question 28

Current GAAP defines lessors' treatment of leases according to Type I and Type II characteristics.Type I characteristics are linked to the critical event criteria for revenue recognition.

Question 29

Managers in lessee companies prefer that leases be treated as capital leases.

Question 30

The FASB and the IASB issued a jointly developed leasing exposure draft which will ultimately result in all leases being treated as capital leases.

Question 31

It is possible that the lessee and the lessor could both treat the same lease as a capital lease.

Question 32

A lessee's minimum lease payments includes the present value of a residual value guarantee.

Question 33

For a lessee,the current ratio deteriorates with a capitalized lease.

Question 34

Residual value guarantees protect lessors against lessees who abuse leased assets.

Question 35

The amount charged to expense over the life of a lease is the same for operating and capital leases.

Question 36

With a leveraged lease,the lessor must treat the lease as a direct financing lease.

Question 37

When a lease meets one of the Type I criteria and both of the Type II criteria,the lessor must treat the lease as a capital lease.

Question 38

Gross Investment in Leased Asset is classified on a lessor's balance sheet as a current asset.

Question 39

The lessor recognizes both interest income and a manufacturer's or dealer's profit during the first year of the lease term when the lease is classified as a sales-type lease.

Question 40

If a company sells an asset for a profit of $175,000 and immediately leases it back with a capital lease,the gain on the sale is recognized immediately as an ordinary gain.

Question 41

To remain in accordance with GAAP,operating leases require note disclosure of the

A)amount of annual rental payments.
B)discounted present value of future lease payments.
C)undiscounted present value of future lease payments.
D)future cash outflows arising from operating leases.

Question 42

If a corporation signs a ten-year lease for a building and the present value of the lease payments is $250,000,the lease is a capital lease if the

A)fair value of the building is $1,000,000.
B)remaining useful life of the building is 20 years.
C)lessor can purchase the building for $5,000 at the end of the lease when the fair value is estimated to be $25,000.
D)building reverts back to the lessor at the end of the lease.

Question 43

A lessee must use which one of the following discount rates to value a capital lease?

A)Prime rate
B)Implicit lease rate
C)Lessee's incremental borrowing rate
D)Lower of implicit lease rate or lessee's incremental borrowing rate

Question 44

Under IFRS,an indicator that could lead to a lease being classified as a finance lease is if the lessee cancels the lease,the lessor's losses will be borne by the lessee.

Question 45

Under IFRS the two additional lessor criteria provided under U.S.GAAP,regarding revenue recognition,are absent.

Question 46

GAAP establishes specific criteria for the treatment of leases.If any of the criteria are met,the lessee

A)must treat the lease as an operating lease.
B)must treat the lease as a capital lease.
C)may choose the treatment if two or less criteria are met.
D)may elect to treat the lease as an operating lease if only one criterion is met.

Question 47

Constructive capitalization provides a preview of how the FASB/IASB exposure draft will affect lessee financial statements.

Question 48

When accounting for an operating lease,which one of the following accounts are charged with the expense on the lessee's income statement?

A)Depreciation Expense
B)Amortization Expense
C)Rent Expense
D)Lease Operating Expense

Question 49

Compared to a firm with a capital lease,operating leases help the lessee firm earn

A)higher asset turnover ratio.
B)lower return on assets.
C)higher debt-to-equity ratio.
D)lower NOPAT.

Question 50

A lessee mistakenly treated an operating lease as a capital lease.How does this mistake impact the following at the inception of the lease? $$\begin{array} { l l c } & \textbf { Total Assets } & \textbf { Total Liabilities } \\\hline\text { a. } & \text { Understated } & \text { Overstated } \\\text { b. } & \text { Understated } & \text { Understated } \\\text { c. } & \text { Overstated } & \text { Overstated } \\\text { d. } & \text { Overstated } & \text { Understated }\end{array}$$

A)Option A
B)Option B
C)Option C
D)Option D

Question 51

When accounting for a capital lease,depreciation expense is equal to the

A)lease payments.
B)principal portion of the lease payments.
C)normal depreciation computed on the depreciable base of the asset.
D)straight-line depreciation only on the full amount of the leased asset.

Question 52

When a lessee has a capital lease,the amount shown for the asset and the amount shown for the related liability are equal

A)only at the lease inception.
B)throughout the life of the lease.
C)only at the termination of the lease.
D)throughout the life of the lease,but only when there is an unguaranteed residual value.

Question 53

A lessee mistakenly treated an operating lease as a capital lease.How does this mistake impact the following at the inception of the lease? $\begin{array}{lcc}&\textbf{Current Ratio}&\textbf{Asset Turnover Ratio}\\\hline\text { a. } & \text { Overstated } & \text { Understated } \\\text { b. } & \text { Understated } & \text { Understated } \\\text { c. } & \text { Overstated } & \text { Overstated } \\\text { d. } & \text { Understated } & \text { Overstated }\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 54

Constructive capitalization occurs when analysts treat capital leases as operating leases and approximate what balance sheet numbers would have been had the leases not been capitalized.

Question 55

Under IFRS,operating lease treatment could be required if the leased asset is so specialized that significant modifications would be needed for another party to use it.

Question 56

A lease is legally a/an ___________ contract.

A)mutually performed
B)executed
C)executory
D)unilateral

Question 57

A lessor mistakenly treated a direct financing lease as an operating lease.How does this mistake impact the following at the end of the first year of the lease term? $\begin{array}{lcc}&\textbf { Rent/Lease Revenue }&\textbf { Interest Revenue }\\\hline\text { a. } & \text { Overstated } & \text { Understated } \\\text { b. } & \text { Understated } & \text { Understated } \\\text { c. } & \text { Overstated } & \text { Overstated } \\\text { d. } & \text { Understated } & \text { Overstated }\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 58

GAAP establishes specific criteria for the treatment of leases.Which of the following does not accurately describe the criteria applicable to a lessee?

A)The lease agreement contains a bargain purchase option.
B)The lease term is equal to or exceeds 75% of the leased asset's useful life.
C)The lease agreement transfers title of the leased asset to the lessee at the end of the lease term.
D)The present value of the minimum lease payments is equal to or greater than 75% of the leased asset's fair value.

Question 59

A lessor mistakenly treated a direct financing lease as an operating lease (the lessor uses straight-line depreciation).How does this mistake impact the following at the end of the first year of the lease term? $\begin{array}{lcc}&\textbf { Net Income }&\textbf { Interest Revenue }\\\hline\text { a. } & \text { Overstated } & \text { Understated } \\\text { b. } & \text { Understated } & \text { Understated } \\\text { c. } & \text { Overstated } & \text { Overstated } \\\text { d. } & \text { Understated } & \text { Overstated }\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 60

The lessor of a building with an operating lease will present on its balance sheet an asset equal to

A)zero.
B)the present value of future lease receipts.
C)the depreciated historical cost of the asset.
D)the fair value of the leased asset.

Question 61

If a lease contains a residual value guarantee,the lessee must

A)add the guaranteed amount to the present value of the minimum lease payments.
B)add the present value of the guaranteed amount to the present value of the minimum lease payments.
C)include the guaranteed amount in the minimum lease payments only if the lessee intends to keep the asset at the end of the lease.
D)ignore the guaranteed amount if the lessee intends to keep the asset at the end of the lease.

Question 62

Blue Manufacturing treats a lathe lease as a/an

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

Question 63

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-The lease liability will be valued on Pepper's balance sheet at (Round all calculations to the nearest whole dollar amount.)

A)$144,475.
B)$157,469.
C)$175,000.
D)$250,000.

Question 64

What is the financing profit of Blue Manufacturing on a leased lathe?

A)$7,000
B)$8,500
C)$10,500
D)$17,500

Question 65

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-At the end of Year 1,Pepper will make a payment of $30,000.Which one of the following entries will properly record this payment? (Round all calculations to the nearest whole dollar amount.)

A) DR Obligation under capital lease $~~~~~~~~$ 30,000
$~~~~~~~~$ CR Cash $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$ 30,000
B) $\begin{array} { l l r r } \text { DR } & \text { Obligation under capital lease } & 14,253 & \\\text { DR } & \text { Interest expense } & 15,747 & \\& \text { CR Cash } & & 30,000\end{array}$
C) $\begin{array} { l l r r } \text { DR } & \text { Obligationunder capital lease } & 9,253 & \\\text { DR } & \text { Maintenance expense } & 5,000 & \\\text { DR } & \text { Interest expense } & 15,747 & \\& \text { CR Cash } & & 30,000\end{array}$
D) $\begin{array} { l l r l } \text { DR } & \text { Obligation under capital lease } & 25,000 & \\\text { DR } & \text { Maintenance expense } & 5,000 & \\& \text { CR Cash } & & 30,000\end{array}$

Question 66

Which one of the following ratios deteriorates with the lessee's capitalization of a lease?

A)Current ratio
B)Return on equity
C)Inventory turnover
D)Common earnings leverage

Question 67

Over the life of a lease,the amount charged to expense is

A)greater for an operating lease.
B)greater for a capital lease.
C)the same for a capital or operating lease.
D)less for a capital lease.

Question 68

The difference between the expense charged with a capital lease and an operating lease is

A)the amount of total expense,with a capital lease higher than an operating lease.
B)the amount of total expense,with an operating lease higher than a capital lease.
C)the number of years that recognize expense.
D)the timing of the expense recognition.

Question 69

What is the manufacturing profit of Blue Manufacturing on a leased lathe?

A)$7,000
B)$8,500
C)$10,500
D)$17,500

Question 70

Executory costs of a lease are treated by the lessee as

A)capitalized costs of the lease.
B)additional interest expense.
C)operating expenses.
D)deferred revenue.

Question 71

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-If the equipment is worth $7,500 at the end of the lease,Pepper will make which one of the following journal entries?

A) DR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$ 7,500
$~~~~~~~~$ CR Leased equipment-Capital lease $~~~~~~~~$$~~~~~~~~$ 7,500
B) DR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$ 12,500
$~~~~~~~~$ CR Leased equipment-Capital lease $~~~~~~~~~~$$~~~~~~~~$ 10,000
$~~~~~~~~$ CR Cash $~~~~~~~~$$~~~~~~~~$$~~~~~~~~~~~~$$~~~~~~~~$$~~~~~~~~~~$$~~~~~~~~~$ 2,500
C) DR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$ 10,000
DR Loss on residual value guarantee $~~~~~~~~$$~~~~~~~~~~~~~~$ 2,500
$~~~~~~~~$ CR Leased equipment - Capital lease $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$ 10,000
$~~~~~~~~$ CR Cash $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~$$~~~~~~~~$ 2,500
D)No entry requireD.

Question 72

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-To value the lease asset,Pepper should use a discount rate of

A)10%.
B)11%.
C)12%.
D)prime rate.

Question 73

To adjust for distortions that arise from off-balance sheet leases when comparing among firms,analysts rely on

A)the balance sheet.
B)the income statement.
C)the statement of stockholders' equity.
D)required note disclosures.

Question 74

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-How much straight-line depreciation expense will Pepper record for Year 1? (Round all calculations to the nearest whole dollar amount.)

A)$14,747
B)$15,362
C)$15,747
D)$17,500

Question 75

If a car dealership leases cars for four years with guaranteed purchase options,guaranteed residual values,and insured financing agreements,these leases are treated as

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

Question 76

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-The Pepper lease is a/an

A)operating lease because the lease value is less than 90% of the fair value of the asset.
B)capital lease because the lease value is 90% of the fair value of the asset.
C)operating lease because the asset reverts to Blue at the end of the lease.
D)capital lease because the lease term is more than 75% of the life of the asset.

Question 77

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-The entry to record this lease on Pepper's books is (Round all calculations to the nearest whole dollar amount.)

A) DR Leased equipment-Capital lease $~~~~~~~$ 144,475
$~~~~~~~~$ CR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$ 144,475
B) DR Leased equipment-Capital lease $~~~~~~~~$ 157,469
$~~~~~~~~$ CR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$ 157,469
C) DR Leased equipment-Capital lease $~~~~~~~~$$~~~~~~~~$ 157,469
DR Discount on lease obligation $~~~~~~~~$$~~~~~~~~~~~~~~~$ 92,531
$~~~~~~~~$ CR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$$~~~~~~~~$ 250,000
D) DR Leased equipment - Capital lease $~~~~~~~~$ 167,469
DR Discount on lease obligation $~~~~~~~~$$~~~~~~~~$ 82,531
$~~~~~~~~$ CR Obligation under capital lease $~~~~~~~~$$~~~~~~~~$$~~~~~~~~$ 250,000

Question 78

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-Upon acquisition,the leased equipment will be valued on Pepper's balance sheet at (Round all calculations to the nearest whole dollar amount.)

A)$144,475.
B)$157,469.
C)$175,000.
D)$250,000.

Question 79

All of the following statements about residual value guarantees are correct except residual value guarantees

A)protect lessors against lessees who abuse leased assets.
B)protect lessees against lessors who abuse leased assets.
C)protects lessors against technological changes.
D)protects lessors against marketplace changes.

Question 80

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } & \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \\\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \\\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022\end{array}$$

-If the equipment is worth $12,500 at the end of the lease,Pepper will make which one of the following journal entries?

A) $\begin{array}{lll}\text { DR } \text { Obligation under capital lease }& 12,500 \\\text { CR Leased equipment-Capital lease }&& 12,500\end{array}$
B) DR Obligation under capital lease $~~~~~~~~$ 10,000
$~~~~~~~~$ CR Leased equipment-Capital lease $~~~~~~~~~~~$ 10,000
C) DR Obligation under capital lease $~~~~~~~~$ 10,000
$~~~~~~~~$ CR Accumulated depreciation $~~~~~~~~$$~~~~~~~~$ 10,000
D)No entry requireD.