Question 1

Henson Manufacturing Company signed a 3-year contract for the use of certain manufacturing equipment with an estimated life of three years.Henson Manufacturing Company cannot cancel the contract.What entry is made to record the contract?

Accepted Answer

DUnder the new lease accounting standards, when a company enters into a lease agreement for an asset with a term that covers the major part of the asset's economic life (in this case, a 3-year lease for equipment with an estimated life of 3 years), it is considered a finance lease. The company must recognize a right-of-use asset (Leased Asset--Manufacturing Equipment) and a lease liability on its balance sheet. Both choices C and D correctly reflect this treatment but are simply presented in reverse order. The correct accounting treatment does not change based on the order of presentation in the journal entry.

Question 2

On January 1, Year 7, Quan Restaurant is planning to enter as the lessee into the two lease agreements described below.Each lease is noncancelable, and Quan does not receive title to either leased property during or at the end of the lease term.All payments required under these agreements are due on January 1 each year.
$\begin{array}{lll}\text { Lessor } & \text { Hadowav Inc. } & \text { Cutter Electronics }\
\text { Type of property } & \text { Oven } & \text { Computer } \
\text { Yearly rental (not including executory costs) } & \$ 15,000 & \$ 4,000 \
\text { Lease term } & 10 \text { years } & 3 \text { years } \
\text { Economic life } & 15 \text { years } & 5 \text { years } \
\text { Purchase option } & \text { None } & \$ 3,000\
\text { Renewal option } & \text { None } & \text { None } \
\text { Fair market value at inception of lease } & \$ 125,000 & \$ 10,200 \
\text { Unguaranteed residual value } & \text { None } & \$ 2,000 \
\text { Lessee's incremental borrowing rate } & 10 \% & 10 \%\
\text { Executory costs paid by } & \text { Lessee } & \text { Lessor } \
\text { Annual executory costs } & \$ 800 & \$ 500 \
\text { Present value factor at 10\% (of an annuity due) } & 6.76 & 2.74
\end{array}$ (CMA adapted, Dec 93 #28) Refer to the Quan Restaurant example.Quan Restaurant should treat the lease agreement with Cutter Electronics as a(n)

Accepted Answer

The lease agreement with Cutter Electronics should be treated as a capital lease because it includes a purchase option at the end of the lease term for $3,000, which is likely to be exercised given the fair market value and the terms of the lease. This option makes the lease meet one of the criteria for a capital lease, which is that the lessee has the option to purchase the leased property at a price that is expected to be sufficiently lower than the fair market value at the date the option becomes exercisable.

Question 3

On January 1, Year 1, Lamp Company acquires new equipment in exchange for a note.Lamp must pay a lump sum of $32,000 on December 31, Year 3.The equipment is being specifically manufactured for Lamp, so no market price exists for the equipment.On similar types of equipment purchases, Lamp has paid 15% interest.The equipment has a five-year life and the company uses straight-line depreciation with a 10% salvage value.
Required:
Prepare journal entries to record the following:
 a.	original acquisition of equipment
b.	any adjusting journal entry necessary at December 31, Year 1
c.	entry to record depreciation at December 31, Year 2
d.	entry to record payment on December 31, Year 3

Accepted Answer

The answer of On January 1, Year 1, Lamp Company...

Question 4

Which of the following is/are not one of the conditions of a capital lease?

Accepted Answer

A capital lease typically involves conditions that lead to the lessee essentially owning the asset or having a significant portion of the benefits and risks of ownership. The incorrect statement, A, says the ownership transfers to the lessor at the end of the lease term, which is not a condition of a capital lease. In a capital lease, the ownership may transfer to the lessee, not the lessor.

Question 5

When a capital lease for equipment is signed, the lessee records an asset called

Accepted Answer

The answer of When a capital lease for equipment is...

Question 6

On January 1, Year 7, Quan Restaurant is planning to enter as the lessee into the two lease agreements described below.Each lease is noncancelable, and Quan does not receive title to either leased property during or at the end of the lease term.All payments required under these agreements are due on January 1 each year.
$\begin{array}{lll}\text { Lessor } & \text { Hadowav Inc. } & \text { Cutter Electronics }\
\text { Type of property } & \text { Oven } & \text { Computer } \
\text { Yearly rental (not including executory costs) } & \$ 15,000 & \$ 4,000 \
\text { Lease term } & 10 \text { years } & 3 \text { years } \
\text { Economic life } & 15 \text { years } & 5 \text { years } \
\text { Purchase option } & \text { None } & \$ 3,000\
\text { Renewal option } & \text { None } & \text { None } \
\text { Fair market value at inception of lease } & \$ 125,000 & \$ 10,200 \
\text { Unguaranteed residual value } & \text { None } & \$ 2,000 \
\text { Lessee's incremental borrowing rate } & 10 \% & 10 \%\
\text { Executory costs paid by } & \text { Lessee } & \text { Lessor } \
\text { Annual executory costs } & \$ 800 & \$ 500 \
\text { Present value factor at 10\% (of an annuity due) } & 6.76 & 2.74
\end{array}$ (CMA adapted, Dec 93 #27) Refer to the Quan Restaurant example.Quan should treat the lease agreement with Hadaway Inc.as a(n)

Accepted Answer

The lease agreement with Hadaway Inc. does not meet any of the criteria for a capital lease, such as transfer of ownership, a bargain purchase option, lease term for the majority of the asset's economic life, or present value of lease payments equal to or exceeding substantially all of the fair market value of the leased property. Therefore, it is treated as an operating lease, and Quan would charge the yearly rental expense of $15,000 plus the executory costs of $800 to annual operations.

Question 7

When a capital lease for equipment is signed, the lessee records a liability called

Accepted Answer

When a capital lease for equipment is signed, the lessee records a liability called lease liability. This liability represents the obligation to make future payments for the use of the equipment over the term of the lease. The lessee will also record an asset, typically called leased equipment or similar, which represents the right to use the equipment during the lease term.

Question 8

U.S.GAAP specifies criteria for a capital lease.Which of the following is not one of the criteria?

Accepted Answer

The criterion that is not specified by U.S.GAAP is that the lease must extend for at least 50% of the asset's expected useful life. U.S.GAAP specifies that a capital lease must meet three of the four following criteria: transfer of ownership at the end of the lease term seems likely because the lessee has a bargain purchase option, the lease extends for at least 75% of the asset's expected useful life, the present value of the contractual minimum lease payments equals or exceeds 90% of the fair value of the asset at the time the lessee signs the lease using a discount rate appropriate for the creditworthiness of the lessee, and the leased asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Question 9

ALT Company, as tenant, acquired for $600,000, paid in a single amount, the right to use an entire office building for the next ten years.ALT expects to rent out the floors in the building to various commercial tenants.As tenant, ALT accounts for its lease as a capital lease amortizing the leasehold asset on a straight-line basis over ten years.ALT, as landlord, signed operating leases with the tenants for all of the rentable space.The rents total $150,000 received at the end of each year for the next ten years, $1.5 million in total.
Required:
 a.	Under current GAAP, can ALT treat the same property as a capital lease and an operating lease?
b.	What is the book value of this property after two years?
 	
Assume, independent of your answer to the preceding question, that the book value of the property after two years is $400,000. On that date, some of the tenants go bankrupt and ALT believes it will be unable to rent their now-vacant space, which will remain empty for the remaining eight years. The fair market value of the remaining leasehold with still-solvent, rent-paying tenants is $300,000.
c.	If the remaining tenants will pay $800,000 in total, with present value $310,000, what entry, if any, will ALT make?
d.	If the remaining tenants will pay $320,000 in total, with present value $290,000, what entry, if any, will ALT make?

Accepted Answer

The answer of ALT Company, as tenant, acquired for $600,000,...

Question 10

Which of the following is/are true of capital lease transactions?

Accepted Answer

The accounting treatment adopted is generally the same for lessors and lessees. Capital leases do not require involvement of a third party, they may or may not include a bargain purchase option, and the lease is valued at the present value of the benefits provided.

Question 11

Bolton Co.leases workout equipment to health clubs.On January 1, Year 1, Bolton Co.leases to Powerhouse Gym, equipment valued at $150,000, for 2 years.The equipment has a 12-year life with zero salvage value.The lease payments equal $2,500 per year, payable on the last day of the year.
Required:
a.Identify the type of lease.Give reasons for your conclusion.
b.State the correct entries to be made by the lessor for this lease.You may assume straight-line depreciation is used by Bolton.

Accepted Answer

The answer of Bolton Co.leases workout equipment to health clubs.On...

Question 12

Firms must disclose in notes to the financial statements the cash flows associated with capital leases and with operating leases for each of the succeeding _____ years and for all years after _____ years in the aggregate.

Accepted Answer

Firms are required to disclose in the notes to their financial statements the cash flows associated with capital leases and operating leases for each of the succeeding five years and for all years after five years in the aggregate. This requirement is part of the effort to provide transparency regarding a company's future financial obligations.

Question 13

Rotor Corporation issues $10,000,000 face value, 10-year, 6% semiannual coupon bonds on January 1, 2013. The bonds require coupon payments on June 30 and December 31 of each year. The market initially priced the bonds to yield 6% compounded semiannually.
The current market yield on these bonds was 6.2% compounded semiannually on June 30, 2013, and 6.6% compounded semiannually on December 31, 2008. Rotor Corporation computes interest expense for each six-month period using the market yield at the beginning of the period.

Required:

a. Compute the carrying value of these bonds on January 1, June 30, and December 31 of 2013, using the fair value option. You may interpolate in the interest tables or use a calculator or use a spreadsheet program to compute the compound interest factors not provided in the tables.

b. Compute the total amount of interest expense and unrealized gain or loss for the first six months of 2013. Do not attempt to separate this amount into interest expense and holding gain or loss.

c. Compute the total amount of interest expense and unrealized gain or loss for the second six months of 2013. Do not attempt to separate this amount into interest expense and holding gain or loss.

Accepted Answer

The answer of  Rotor Corporation issues $10,000,000 face value,...

Question 14

On January 1, Year 6, Pearson Corporation issued $1,000,000 face value, 20-year bonds.The bonds carry coupon interest of 6 percent per year, payable semiannually on June 30 and December 31.The bonds were initially priced on the market to yield 8 percent, compounded semiannually (for an effective annualized yield greater than 8 percent).
Required:
 
a.	Compute the issue price of these bonds on January 1, Year 6.
b.	Compute the amount of interest expense on these bonds for Year 6, assuming that the firm uses the effective-interest method of amortizing bond premium or discount.
c.	Assume for this part that the firm recorded interest expense in Part b. in an amount equal to interest paid for the year. That is, it failed to record amortization of bond premium or discount. Indicate the effect (direction and amount) of this omission on the line items in the statement of cash flows using "O/S" (overstated), "U/S" (understated), or "No" (no effect). Ignore income taxes.
$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$Direction$\quad$$\quad$$\quad$$\quad$$\quad$ Amount
1) Net Income
2) Adjustments that are added to net income
3) Adjustments that are subtracted from net income
4) Cash Flow from Operations

Accepted Answer

The answer of On January 1, Year 6, Pearson Corporation...

Question 15

Why do lessees tend to prefer the operating lease method to the capital lease method?

Accepted Answer

The operating lease method is preferred by lessees because it does not add to the long-term debt on the balance sheet, making the company appear less risky compared to using the capital lease method. This approach also spreads the expense recognition over the life of the lease, avoiding the front-loading of expenses that occurs with capital leases.

Question 16

Match between columns
                        Premises: __________ A firm signs a 5-year lease for equipment with a 7-year life.
__________ A firm signs a 16-year lease for equipment with a 20-year life.
__________ A firm signs a lease for property with a fair market value of $20,000. The present value of the lease payments is $16,000.
__________ A firm signs a lease for property with a fair value of $90,000. The present value of the lease payments is $85,000.
__________ A firm signs a lease for equipment which will allow the lessee to purchase the equipment at the end of the lease for one-half the fair market value.

Accepted Answer

The Answer of capital and operating is...

Question 17

(CMA adapted, Dec 92 #10) There are many similarities between lessee and lessor accounting for the capitalization of leases.Which one of the following is a criterion for the capitalization of a lease by a lessee?

Accepted Answer

The criterion for capitalization of a lease by a lessee includes the transfer of ownership of the property to the lessee by the end of the lease term.

Question 18

Which of the following is/are not one of the conditions of a capital lease?

Accepted Answer

A capital lease condition requires the lease to extend for at least 75 percent of the asset's life, not 70 percent.

Question 19

The annual report of Sign Corporation for Year 1 reports capital leases requiring payments totaling $228 million over future years, including $58 million payable at the end of Year 2.The interest rate on these obligations is 12 percent and their present value (discounted at 12 percent) at the end of Year 1 was $181 million.The assets financed by capital leases appear on the Year 1 year-end balance sheet at $220 million.Assume no new leases were entered into during Year 2 and that leasehold assets have a remaining useful life of 10 years at the start of Year 2, but no salvage value.Ignore income taxes.
Required:
 a.	What would be the total expense for Year 2 for the leasehold assets and the financing thereof?
b.	What would be the total cash expenditure during Year 2 related to the leasehold assets and the financing thereof?
c.	What would be the balance sheet amount for leasehold assets at the end of Year 2?
d.	What would be the balance sheet amount for lease obligations at the end of Year 2?

Accepted Answer

The answer of The annual report of Sign Corporation for...

Question 20

U.S.GAAP specifies criteria for a capital lease.Which of the following is not one of the criteria?

Accepted Answer

The answer of U.S.GAAP specifies criteria for a capital lease.Which...

Quiz 11: Notes, Bonds, and Leases

Henson Manufacturing Company signed a 3-year contract for the use of certain manufacturing equipment with an estimated life of three years.Henson Manufacturing Company cannot cancel the contract.What entry is made to record the contract?

Which of the following is/are not one of the conditions of a capital lease?

When a capital lease for equipment is signed, the lessee records an asset called

When a capital lease for equipment is signed, the lessee records a liability called

U.S.GAAP specifies criteria for a capital lease.Which of the following is not one of the criteria?

Which of the following is/are true of capital lease transactions?

Firms must disclose in notes to the financial statements the cash flows associated with capital leases and with operating leases for each of the succeeding _ years and for all years after _ years in the aggregate.

Why do lessees tend to prefer the operating lease method to the capital lease method?

Indicate whether each of the following independent transactions is a capital (C) or operating (O) lease.

(CMA adapted, Dec 92 #10) There are many similarities between lessee and lessor accounting for the capitalization of leases.Which one of the following is a criterion for the capitalization of a lease by a lessee?

Which of the following is/are not one of the conditions of a capital lease?

U.S.GAAP specifies criteria for a capital lease.Which of the following is not one of the criteria?