Question 1

Minimum lease payments are payments the lessee is obligated to make or can be expected to make in connection with the leased property. In computing minimum lease payments, all of the following would be included except the

Accepted Answer

The present value of the cost of the leased asset is not included in the computation of minimum lease payments. Minimum lease payments typically include minimum rental payments, penalties for failure to renew or extend the lease, and the bargain purchase option, but not the present value of the cost of the leased asset itself.

Question 2

Under an operating lease, a rent expense accrues day by day to the lessee as the property is used. This amount of rent expense is

Accepted Answer

Under an operating lease, the rent expense is recognized as an expense in the income statement in the periods that benefit from the use of the leased asset, rather than being capitalized on the balance sheet. This reflects the matching principle, where expenses are recognized in the period they help to generate revenues.

Question 3

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?

Accepted Answer

The lessee must include the present value of the bargain purchase option in the minimum lease payments because it is expected that the lessee will exercise the option, thus increasing the present value of the lease payments.

Question 4

If a lease transaction is accorded capital lease treatment rather than operating lease treatment, it would have what impact on the following financial items of the lessee? 
$\begin{array}{ccc}
 & & & \text {Return on} \
 & \text {Reported Debt} &\text { Total Assets} &\text { Total Assets }\\end{array}$

Accepted Answer

Capital lease treatment increases reported debt and total assets because the leased asset and corresponding liability are recorded on the balance sheet. Return on total assets decreases because the increase in assets (denominator) is larger proportionally than any increase in net income (numerator), reducing the ratio.

Question 5

In addition to the four criteria that a lessee must assess in deciding whether to classify a lease transaction as a capital lease, a lessor must meet two additional criteria. These include (1) the collectibility of the payments required from the lessee is reasonably predictable, and (2)

Accepted Answer

For a lessor to classify a lease as a capital lease, there must be no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor under the lease.

Question 6

Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor? 
$\begin{array}{cccc}
\text {Transfers Ownership} &\text {Contains Bargain }&\text {Collectibility of Lease}&\text {Any Important }\
\text {By End Of Lease?}&\text {Purchase Option?}&\text {Payments Assured?}&\text {Uncertainties?} \\end{array}$

Accepted Answer

For a lease to be classified as a sales-type or direct-financing lease by the lessor, certain criteria must be met, such as the collectibility of lease payments being reasonably assured and there being no important uncertainties regarding additional costs yet to be incurred by the lessor. Option A meets these conditions.

Question 7

In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as

Accepted Answer

The lease receivable in a direct-financing lease is defined as the present value of minimum lease payments, reflecting the amount the lessor expects to receive over the term of the lease.

Question 8

A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts?

Accepted Answer

The answer of A lessor with a sales-type lease involving...

Question 9

With respect to the computation of minimum lease payments by the lessee, how are the following items handled in the computation?

$\quad $$\quad $$\text{ GuaranteedUnguaranteed } $
$\begin{array}{cc}
 &\text{ Residual Value }&\text {Residual Value }\\end{array}$

Accepted Answer

Guaranteed residual values are included in the computation of minimum lease payments by the lessee because they represent amounts the lessee guarantees to make the lessor whole at the end of the lease term. Unguaranteed residual values are excluded because they represent amounts beyond the lessee's obligation and are assumed by the lessor.

Question 10

On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Penn to make annual payments of $100,000 at the end of each year for ten years with title to pass to Penn at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Penn uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. With respect to this capitalized lease, Penn should record for 2008

Accepted Answer

$671,008 × .08 = $53,681, $671,008 ÷ 15 = $44,734.

Question 11

On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter 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) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.)

Accepted Answer

$3,000,000 ÷ 6.14457 = $488,236 (PV of Ordinary Annuity Table).

Question 12

On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter 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) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-What is the amount of the total annual lease payment?

Accepted Answer

$488,236 + $10,000 = $498,237.

Question 13

On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter 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) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-From the lessor's viewpoint, what type of lease is involved?

Accepted Answer

FV exceeds cost

Question 14

On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter 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) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-From the lessee's viewpoint, what type of lease exists in this case?

Accepted Answer

This lease qualifies as a capital lease from the lessee's viewpoint because it meets several criteria for capital lease classification: the lease term is equal to the economic life of the asset (10 years), title transfers to the lessee at the end of the lease term, and the lessee knows the implicit rate set by the lessor, which is indicative of a financing arrangement.

Question 15

Huffman Company leases a machine from Lincoln Corp. under an agreement which meets the criteria to be a capital lease for Huffman. The six-year lease requires payment of $102,000 at the beginning of each year, including $15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Huffman should record the leased asset at

Accepted Answer

($102,000 - $15,000) × 4.99271 = $434,366.

Question 16

On December 31, 2007, Pool Corporation leased a ship from Renn Company for an eight-year period expiring December 30, 2015. Equal annual payments of $200,000 are due on December 31 of each year, beginning with December 31, 2007. The lease is properly classified as a capital lease on Pool's books. The present value at December 31, 2007 of the eight lease payments over the lease term discounted at 10% is $1,173,685. Assuming all payments are made on time, the amount that should be reported by Pool Corporation as the total obligation under capital leases on its December 31, 2008 balance sheet is

Accepted Answer

$1,173,685 - $200,000 = $973,685 × .10 = $97,369
$973,685 - ($200,000 - $97,369) = $871,054.

Question 17

On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of each year for five years with title to pass to Dalton at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $208,493 at an effective interest rate of 10%.
-In 2008, Dalton should record interest expense of

Accepted Answer

($208,493 - $50,000) × .10 = $15,849.

Question 18

On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of each year for five years with title to pass to Dalton at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $208,493 at an effective interest rate of 10%.
-In 2009, Dalton should record interest expense of

Accepted Answer

[$158,493 - ($50,000 - $15,849)] × .10 = $12,434.

Question 19

On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are due on December 31 of each year, beginning with December 31, 2008. The lease is properly classified as a capital lease on Dodd's books. The present value at December 31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264. Assuming the first payment is made on time, the amount that should be reported by Dodd Corporation as the lease liability on its December 31, 2008 balance sheet is

Accepted Answer

$880,264 - $150,000 = $730,264.

Question 20

On January 1, 2008, Carley Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Carley to make annual payments of $60,000 at the end of each year for five years with title to pass to Carley at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Carley uses the straight-line method of depreciation for all of its fixed assets. Carley accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $227,448 at an effective interest rate of 10%.
-With respect to this capitalized lease, for 2008 Carley should record

Accepted Answer

$227,448 × .10 = $22,745; ($227,448 - 0) ÷ 7 = $32,493.

Quiz 17: Accounting for Leases