Deck 15: Leases

Question 1

Draper Corp. leased a new building and land from Baylor Leasing Inc. for 25 years. At the inception of the lease the building and land have fair market values of $200,000 and $25,000, respectively. The building has an expected economic life of 30 years. Which of the following statements is correct regarding Draper's treatment of the lease?

A) Draper should treat the lease as a capital lease even though there is no bargain purchase option and no automatic transfer of ownership at the termination of the lease.
B) Draper should treat the lease as a capital lease only if there is either a bargain purchase option or an automatic transfer of ownership at the termination of the lease.
C) Draper should treat the lease as a capital lease provided that the land and building are recorded in separate asset accounts and accounted for separately.
D) Draper should treat the lease as a capital lease only if Baylor treats the transaction as a leveraged lease.

Answer 1

A

Question 2

Lease Y does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease Z does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases?
Lease Y Lease Z

A) Capital lease Operating lease
B) Capital lease Capital lease
C) Operating lease Capital lease
D) Operating lease Operating lease

Answer 2

B

Question 3

Which of the following statements characterizes an operating lease?

A) The lessee records depreciation and interest.
B) The lessee records the lease obligation related to the leased asset.
C) The lessor transfers title of the leased property to the lessee for the duration of the lease term.
D) The lessor records depreciation and lease revenue.

Answer 3

D

Question 4

In a lease that is recorded as an operating lease by the lessee, the equal monthly rental payments should be

A) allocated between interest expense and depreciation expense.
B) allocated between a reduction in the liability for leased assets and interest expense.
C) recorded as a reduction in the liability for leased assets.
D) recorded as rental expense.

Question 5

Which of the following statements concerning guaranteed residual values is appropriate for the lessee?

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

Question 6

One of the four general criteria for a capital lease is that the present value at the beginning of the lease term of the minimum lease payments equals or exceeds

A) the property's fair market value.
B) 90 percent of the property's fair market value.
C) 75 percent of the property's fair market value.
D) 50 percent of the property's fair market value.

Question 7

What are the three types of period costs that a lessee experiences with capital leases?

A) Interest expense, amortization expense, executory costs
B) Amortization expense, executory costs, lease expense
C) Executory costs, interest expense, lease expense
D) Lease expense, executory costs, initial costs

Question 8

The lessee's balance sheet liability for a capital lease would be periodically reduced by the

A) minimum lease payment.
B) minimum lease payment plus the amortization of the related asset.
C) minimum lease payment less the amortization of the related asset.
D) minimum lease payment less the portion of the minimum lease payment allocable to interest.

Question 9

A lease contains a bargain purchase option. In determining the lessee's capitalizable cost at the beginning of the lease term, the payment called for by the bargain purchase option would be

A) subtracted at its present value.
B) added at its exercise value.
C) added at its present value.
D) subtracted at its exercise price.

Question 10

Which of the following statements characterizes lessor accounting for residual values?

A) Guaranteed residual values are included in the gross investment amount, but unguaranteed residual values are excluded from the gross investment.
B) Unguaranteed residual values are included in the gross investment amount, but guaranteed residual values are excluded from the gross investment.
C) Guaranteed residual values and unguaranteed residual values are excluded from the gross investment.
D) Guaranteed residual values and unguaranteed residual values are included in the gross investment.

Question 11

Which of the following would be considered an executory cost?

A) Minimum lease payments
B) Interest expense incurred
C) Bargain purchase option
D) Maintenance costs

Question 12

Johnson Institute leased a new machine having an expected useful life of 12 years. The noncancelable lease term is 10 years, and Johnson may exercise a purchase option at the end of the noncancelable term. The machine should be capitalized by Johnson and depreciated over

A) 9 years.
B) 12 years.
C) 10 years.
D) 10 or 12 years at Johnson's option.

Question 13

Initial direct costs incurred by a lessor in consummating a sales-type lease are

A) charged to unearned income in the first period of the lease term.
B) charged to cost of sales in the first period of the lease term.
C) deferred and allocated over the lease term in proportion to the recognition of rent revenue.
D) deferred and allocated over the lease term on a straight-line basis.

Question 14

Which of the following statements characterizes a sales-type lease?

A) The lessor recognizes only interest revenue over the life of the asset.
B) The lessor recognizes only interest revenue over the lease term.
C) The lessor recognizes a dealer's profit at lease inception and interest revenue over the lease term.
D) The lessor recognizes a dealer's profit at lease inception and interest revenue over the asset life.

Question 15

An eight-year capital lease specifies equal minimum annual lease payments. Part of this payment represents interest and part represents a reduction in the net lease liability. The portion of the minimum lease payment in the fourth year applicable to the reduction of the net lease liability should be

A) the same as in the third year.
B) less than in the third year.
C) less than in the fifth year.
D) more than in the fifth year.

Question 16

For a capital lease, the amount recorded initially by the lessee as a liability should

A) exceed the present value at the beginning of the lease term of minimum lease payments during the lease term.
B) exceed the total of the minimum lease payments during the lease term.
C) not exceed the fair value of the leased property at the inception of the lease.
D) equal the total of the minimum lease payments during the lease term.

Question 17

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

A) the estimated economic life of the property.
B) 90 percent of the estimated economic life of the property.
C) 75 percent of the estimated economic life of the property.
D) 50 percent of the estimated economic life of the property.

Question 18

Johntech Inc. leased a new machine having an expected useful life of 30 years from Carbide Co. Terms of the noncancelable 25-year lease were that Johntech would gain title to the property upon payment of a sum equal to the fair market value of the machine at the termination of the lease. Johntech accounted for the lease as a capital lease and recorded an asset and a liability in the financial records. The asset recorded under this lease should properly be amortized over

A) 5 years (the period of actual ownership).
B) 22.5 years (75 percent of the 30-year asset life).
C) 25 years (the term of the lease).
D) 30 years (the total asset life).

Question 19

Generally accepted accounting principles require that certain lease agreements be accounted for as purchases. The theoretical basis for this treatment is that a lease of this type

A) effectively conveys all of the benefits and risks incident to the ownership of property.
B) is an example of form over substance.
C) provides the use of the leased asset to the lessee for a limited period of time.
D) must be recorded in accordance with the concept of cause and effect.

Question 20

Which one of the following items is not part of the minimum lease payments from the standpoint of the lessee?

A) The minimum rental payments called for by the lease
B) Any guarantee the lessee is required to make at the end of the lease term regarding any deficiency from a specified minimum
C) Any estimated residual value at the end of the lease term
D) Any payment the lessee must make at the end of the lease term to purchase the leased property under a bargain purchase option

Question 21

Jordan Co. leased a machine on December 31, 2011. Annual payments under the lease are $110,000 (which includes $10,000 annual executory costs) and are due on December 31 each year, for a ten-year period. The first payment was made on December 31, 2011, and the second payment was made on December 31, 2012. According to the agreement, the lease payments are discounted at 10 percent over the lease term. Assume the present value of minimum lease payments at the inception of the lease and before the first annual payment was $615,000 and Jordan appropriately classified the lease as a capital lease. What is the lease liability Jordan should report in its December 31, 2012, balance sheet?

A) $466,500
B) $515,000
C) $534,150
D) $576,500

Question 22

On January 1, Twix Company as lessee signed a ten-year noncancelable lease for a machine with annual payments of $60,000. The first payment was also made on January 1. Twix appropriately treated this transaction as a capital lease. The ten lease payments have a present value of $405,000 at January 1, based on implicit interest of 10 percent. For the first year, Twix should record interest expense of

A) $0.
B) $6,000.
C) $34,500.
D) $40,500.

Question 23

On December 31, 2011, Gephardt Enterprises leased equipment from B & B Equipment Rental. Pertinent lease transaction data are as follows:

Gephardt should record the equipment on the books at

A) $1,400,000.
B) $1,022,000.
C) $978,000.
D) $0.

Question 24

In order for a lease to be considered a finance (or capital) lease, international accounting standards require that a lease agreement

A) transfers substantially all risks and rewards incident to ownership of an asset to the lessee.
B) contains a provision requiring transfer of title to the lessee by the end of the lease term.
C) provides that the term of the lease contract be longer than one year.
D) provides for a bargain purchase option.

Question 25

Aerotech Inc., a dealer in machinery and equipment, leased equipment to Quality Products on July 1, 2011. The lease is appropriately accounted for as a sale by Aerotech and as a purchase by Quality. The lease is for a ten-year period (the useful life of the asset) expiring June 30, 2021. The first of ten equal annual payments of $250,000 was made on July 1, 2011. Aerotech had purchased the equipment for $1,337,500 on January 1, 2011, and established a list selling price of $1,687,500 on the equipment. Assume that the present value at July 1, 2011, of the rent payments over the lease term discounted at 12 percent (the appropriate interest rate) was $1,582,500. What is the amount of profit on the sale and the amount of interest income that Aerotech should record for the year ended December 31, 2011?

A) $245,000 and $94,950
B) $245,000 and $79,950
C) $350,000 and $79,950
D) $350,000 and $94,950

Question 26

Which of the following is (are) not correct regarding disclosure requirements lessees?

A) I only
B) II only
C) Both I and II
D) Both III and IV

Question 27

Hazard Inc. manufactures equipment that is sold or leased. On December 31, 2011, Hazard leased equipment to Robards for a five-year period expiring December 31, 2016, at which date ownership of the leased asset will be transferred to Robards. Equal $40,000 payments under the lease are due on December 31 of each year. The first payment was made on December 31, 2011. Collectibility of the remaining lease payments is reasonably assured, and Hazard has no material cost uncertainties. The normal sales price of the equipment is $154,000 and cost is $120,000. For the year ended December 31, 2011, how much income should Hazard recognize from the lease transaction?

A) $46,000
B) $40,000
C) $34,000
D) $28,000

Question 28

On January 1, 2011, Shak, Inc. signed a noncancelable lease for a sneaker shining machine. The machine has an estimated useful life of nine years. The term of the lease is a six-year term with title passing to Shak at the end of the lease. The agreement called for annual payments of $40,000 starting at the end of the first year. Assume aggregate lease payments were determined to have a present value of $200,000, based on implicit interest of 12 percent. What amount of interest expense should Shak report in its 2011 income statement from this lease transaction?

A) $0
B) $16,000
C) $24,000
D) $33,333

Question 29

From the standpoint of the lessee, the minimum lease payment includes all of the following except

A) the guaranteed residual value.
B) the lessee's obligation to pay executory costs.
C) the bargain purchase option.
D) any payment that the lessee must make upon failure to extend or renew the lease.

Question 30

Slice Company manufactures equipment that they sell or lease. On December 31, 2011, Slice leased equipment to Hook Company for a five-year period after which ownership of the leased asset will be transferred to Hook. The lease calls for equal annual payments of $50,000, due on December 31 of each year. The first payment was made on December 31, 2011. The normal sales price of the equipment is $220,000, and cost is $176,000. For the year ended December 31, 2011, what amount of income should Slice report from the lease transaction?

A) $10,000
B) $30,000
C) $44,000
D) $74,000

Question 31

On January 1, Gregory Company signed a ten-year noncancelable lease for a new machine, requiring $40,000 annual payments at the beginning of each year. The machine has a useful life of 15 years, with no salvage value. Title passes to Gregory at the lease expiration date. Gregory uses straight-line depreciation for all of its plant assets. Aggregate lease payments have a present value on January 1 of $252,000, based on an appropriate rate of interest. For the first year, Gregory should record depreciation (amortization) expense for the leased machine at

A) $40,000.
B) $25,200.
C) $16,800.
D) $14,133.

Question 32

Stockton, Inc. leased machinery with a fair value of $250,000 from Layton Machine Co. on December 31, 2011. The contract is a six-year noncancelable lease with an implicit interest rate of 10 percent. The lease requires annual payments of $50,000 beginning December 31, 2011. Stockton appropriately accounted for the lease as a capital lease. Stockton's incremental borrowing rate is 12 percent. Assuming the present value of an annuity due of 1 for 6 years at 10 percent is 4.7908 and the present value of an annuity due of 1 for 6 years at 12 percent is 4.6048, what is the lease liability that Stockton should report on the balance sheet at December 31, 2011?

A) $189,540
B) $200,000
C) $230,240
D) $239,540

Question 33

Epson Distributing leased a machine for a period of eight years, contracting to pay $200,000 at the beginning of the lease term on December 31, 2011, and $200,000 annually on December 31 for each of the next seven years. The present value of the eight rent payments over the lease term, appropriately discounted at 10 percent, is $1,174,000. On its December 31, 2012, balance sheet, Epson should report a liability under capital lease of

A) $871,400.
B) $876,600.
C) $974,000.
D) $1,091,400.

Question 34

Which of the following is true regarding the lease term?

A) The lease term does not include all periods covered by bargain renewal options.
B) The lease term includes all periods for which failure to renew imposes a penalty sufficiently high that the lessee probably will renew.
C) The lease term may extend beyond the date a bargain purchase option becomes exercisable.
D) The lease term does not include all periods representing renewals or extensions of the lease at the lessor's option.

Question 35

On January 1, 2011, Collins Company leased a warehouse to Cuthbert under an operating lease for ten years at $80,000 per year, payable the first day of each lease year. Collins paid $36,000 to a real estate broker as a finder's fee. The warehouse is depreciated at $20,000 per year. During 2011, Collins incurred insurance and property tax expense totaling $15,000. Collins' net rental income for 2011 should be

A) $9,000.
B) $41,400.
C) $44,000.
D) $45,000.

Question 36

State Repairs acquires equipment under a noncancelable lease at an annual rental of $45,000, payable in advance for five years. After five years, there is a bargain purchase option of $75,000. The appropriate interest rate is 12 percent. What is the total present value of the lease and the first year's interest expense?

A) $224,234 and $21,508
B) $224,234 and $26,908
C) $204,771 and $21,508
D) $204,771 and $19,173

Question 37

On March 1, 2011, Sturdy Corp. became the lessee of new equipment under a noncancelable six-year lease. The total estimated economic life of this equipment is ten years. The fair value of this equipment on March 1, 2011, was $100,000. The lease does not meet the criteria for classification as a capital lease with respect to transfer of ownership of the leased asset, or bargain purchase option, or lease term. Nevertheless, Sturdy must classify this lease as a capital lease if, at inception of the lease, the present value of the minimum lease payments (excluding executory costs) is equal to at least

A) $67,500.
B) $75,000.
C) $90,000.
D) $100,000.

Question 38

Baxter Company leased equipment to Fritz Inc. on January 1, 2011. The lease is for an eight-year period expiring December 31, 2018. The first of eight equal annual payments of $900,000 was made on January 1, 2011. Baxter had purchased the equipment on December 29, 2010, for $4,800,000. The lease is appropriately accounted for as a sales-type lease by Baxter. Assume that the present value at January 1, 2011, of all rent payments over the lease term discounted at a 10 percent interest rate was $5,280,000. What amount of interest revenue should Baxter record in 2012 (the second year of the lease period) as a result of the lease?

A) $490,000
B) $480,000
C) $438,000
D) $391,800

Question 39

Which of the following is not a required disclosure for lessors?

A) Total of minimum sublease rentals to be received in the future under noncancelable subleases
B) Unearned interest revenue
C) Unguaranteed residual values accruing to the benefit of the lessor
D) A general description of the lessor's leasing arrangements

Question 40

If the residual value of a leased asset is greater than the amount guaranteed by the lessee, the lessee

A) pays the lessor for the difference.
B) recognizes a gain at the end of the lease term.
C) has no obligation related to the residual value.
D) pays the lessor for the difference.

Question 41

An asset with a market value of $100,000 is leased on January 1, 2011. Five annual lease payments are due each January 1 beginning January 1, 2011. The lessee guarantees the $40,000 residual value of the asset as of the end of the lease term on December 31, 2015. The lessor's implicit interest rate is 8%.
What is the annual lease payment?

A) $18,227
B) $16,877
C) $23,191
D) $25,046

Question 42

On December 1, 2011, Blake Inc. signed an operating lease for a warehouse for ten years at $24,000 per year. Upon execution of the lease, Blake paid $48,000 covering rent for the first two years. How much should be shown in Blake's income statement for the year ended December 31, 2011, as rent expense?

A) $0
B) $2,000
C) $24,000
D) $48,000

Question 43

Lofgreen Company leased an asset for use in its factory. The lease agreement specifies that Lofgreen is to make annual payments of $2,818 payable at the end of each year. The lessor classified the lease as a direct-financing lease since Lofgreen was allowed to lease the asset at its cost of $14,000 (the present value of the lease payments). The lessor receives a 12 percent rate of return on the lease. The estimated residual value at the end of the lease term is zero.
If the lease was classified as a capital lease by Lofgreen, how much annual depreciation would Lofgreen record using the straight-line method?

A) $1,400
B) $1,750
C) $1,310
D) $2,818

Question 44

A lessee wants to lease an asset on a long-term noncancelable basis, but wants to avoid capitalizing the lease. The lessee is considering the following strategies to accomplish its objective:

Which of the strategies above will provide the desired result?

A) None
B) 1 and 3
C) 1 and 4
D) only 2

Question 45

Marshall, Inc., leased equipment to Gadsby Company on January 1, 2011. The lease is for a five-year period ending January 1, 2016. The first equal annual payment of $1,200,000 was made on January 1, 2011. The cash selling price of the equipment is $5,174,552, which is equal to the present value of the lease payments at 8%. Marshall purchased the equipment for $4,300,000.
Marshall should account for this lease as

A) an operating lease.
B) a direct-financing lease.
C) a sale-type lease.
D) leveraged lease.

Question 46

On January 1, 2011, Larsen Corporation sold a machine to Parson Corporation and simultaneously leased it back for ten years. The following information is available regarding the lease:

How much profit should Larsen recognize on January 1, 2011, on the sale of the machine?

A) $0.
B) $37,211
C) $90,000
D) $37,500

Question 47

Walker, Inc., leased a machine from Holden Company. The lease term was for a five-year period beginning January 1, 2011. Equal annual lease payments of $3,000 are due on December 31 of each year. The implicit rate of the lease is 10% and is known to Walker. Walker has properly applied the lease capitalization criteria and as a result, accounts for the lease as a capital lease. The first payment under the lease was made on December 31, 2011 as scheduled.
How much should Walker classify as the current portion of the lease liability at December 31, 2011?

A) $2,049
B) $7.460
C) $3,000
D) $9,509

Question 48

Wallace Corporation entered into a direct financing lease (interest rate 12 percent) to lease Grommit an asset that cost Wallace $90,000. The lease specified annual year-end payments for seven years. The lease also specified that, along with the last payment, Grommit could purchase the asset for $8,000 cash. Under this lease agreement, Grommit will be required to pay annual payments of

A) $11,714.
B) $12,858.
C) $17,966.
D) $18,928.

Question 49

In a lease that is recorded as a direct financing lease by the lessor, unearned revenue

A) should be amortized over the period of the lease using the interest method.
B) should be amortized over the period of the lease using the straight-line method.
C) does not arise.
D) should be recognized in full at the inception of the lease.

Question 50

Potter Corporation leased used equipment to Weasley, Inc. The equipment originally had a 10-year life and the lease to Weasley is for the last two of the ten-year life of the asset. The lease calls for four semiannual lease payments of $2,000 to be made at the end of each year in the life of the lease. The lease agreement contains no transfer of title or bargain purchase option provisions.
What is the amount of the leased asset that should be recorded on Weasley's books at the beginning of the lease?

A) $2,000
B) $7,092
C) $4,000
D) $-0-

Question 51

The lessor capitalizes and amortizes initial direct costs for all types of leases except

A) operating leases.
B) sales-type leases.
C) direct-financing leases.
D) There are no exceptions.

Question 52

On December 31, 2011, Cooke Company leased a machine under a capital lease for a period of ten years, contracting to pay $100,000 on signing the lease and $100,000 annually on December 31 of the next nine years. The present value at December 31, 2011, of the ten lease payments over the lease term discounted at 10 percent was $676,000. At December 31, 2012, Cooke's total capital lease liability is

A) $486,000.
B) $518,000.
C) $533,600.
D) $607,960.

Question 53

Waters Company entered into a direct-financing lease with Toll Company for the use of an asset which cost Waters $240,000. The lease agreement contained a bargain purchase option effective immediately after the fifth rental, which provided that Toll could purchase the asset at that time. The estimated life of the asset was 10 years with an estimated residual value of $400. Assuming that Toll uses straight-line depreciation, Toll's annual depreciation expense would be

A) $22,200.
B) $23,960.
C) $44,400.
D) $48,000.

Question 54

On January 2, 2011, Boston Corporation entered into a 10-year noncancelable lease requiring year-end payments of $60,000. The incremental borrowing rate for Boston is 10%. The lessor's implicit rate (which is known by Boston) is 12%. The lease contains no transfer of title or bargain purchase option provisions. The leased property has an estimated economic life of 12 years. At what amount should the lease be capitalized by Boston?

A) $0
B) $339,012
C) $368,676
D) $600,000

Question 55

In a lease that is recorded as an operating lease by the lessee, the equal monthly rental payments should be

A) allocated between interest expense and depreciation expense.
B) allocated between a reduction of the liability for leased assets and interest expense.
C) recorded as a reduction in the liability for leased assets.
D) recorded as a rental expense.

Question 56

A lease agreement included the following provisions:

How much interest revenue is recognized in 2011 by the lessor, assuming a calendar-year fiscal year?

A) $3,600
B) $3,419
C) $2,550
D) $2,118

Question 57

Rawlings Company entered into a direct-financing lease with Zubin Corporation, which called for seven annual rentals of $3,500 at an interest rate of 12 percent. The payments are to be paid and the end of each year. The lease also contained a bargain purchase option allowing Zubin to purchase the asset for $2,500 after making the seventh annual rental payment.
What was the cost of the asset?

A) $17,104
B) $18,473
C) $25,631
D) $27,000

Question 58

Marshall, Inc., leased equipment to Gadsby Company on January 1, 2011. The lease is for a five-year period ending January 1, 2016. The first equal annual payment of $1,200,000 was made on January 1, 2011. The cash selling price of the equipment is $5,174,552, which is equal to the present value of the lease payments at 8%. Marshall purchased the equipment for $4,300,000.
For 2011, Marshall should report interest revenue of

A) $317,964.
B) $344,000.
C) $413,964.
D) $517,455.

Question 59

K Corporation agreed to lease a computer, at cost, to L Company for $36,000 payable each year-end for seven years without a bargain purchase option, or, as an equivalent alternative, for $33,000 per year with a bargain purchase option, after the seventh rental. If the lease is a direct financing lease, and K expects to earn a 12 percent return, the amount of cash L Company would need to pay for the bargain purchase option is

A) $30,266.
B) $26,340.
C) $21,000.
D) $9,948.

Question 60

Barnum, Inc., leased equipment from Baily Supply on December 31, 2011. The lease term is for the 10-year period expiring December 30, 2021. The useful life of the leased asset is 10 years. Equal annual payments under the lease are $100,000 due on December 31 of each year. The first payment was made on December 31, 2011. Barnum's incremental borrowing rate was 12% at December 31, 2011. Baily's implicit rate for the lease is 10% and is known by Barnum. Barnum appropriately accounts for the lease as a capital lease.
What is the balance in Barnum's "Liability Under Lease Agreements" account at December 31, 2012?

A) $533,492
B) $545,010
C) $643,492
D) $800,000

Question 61

Alvin Company entered into a lease agreement with Theodore, Inc., to lease an asset that cost Alvin $120,000. The lease agreement requires five annual year-end rentals of $40,000 each. Alvin's implicit rate on the lease is 15 percent.
Alvin's dealer profit on this lease would be

A) $14,086 loss.
B) $14,086 gain.
C) $18,000 gain.
D) $80,000 gain.

Question 62

If the lessee and the lessor use different interest rates to account for a capital lease, then

A) the lease will never be accounted for as a capital lease by the lessee.
B) total expenses (or revenues) will be equal for both lessee and lessor.
C) total expenses (or revenues) will be different for the lessee and the lessor.
D) GAAP has been violated since the lessor and the lessee are not allowed to use different interest rates in accounting for capital leases.

Question 63

Johnson, Inc., leased an asset to Raymond Corporation. The cost of the asset to Johnson was $8,000. Terms of the lease specify four-year life for the lease, an annual interest rate of 15 percent, and four year-end rental payments. The lease qualifies as a capital lease and is classified as a direct-financing lease. The asset reverts to Johnson after the fourth year, when its residual value is estimated to be $1,000. The amount of each rental payment is

A) $2,000.
B) $2,335.
C) $2,501.
D) $2,602.

Question 64

Farewell Inc. leases equipment to its customers under noncancelable leases. On January 1, 2011, Farewell leased equipment costing $400,000 to Norman Co., for nine years. The rental cost was $44,000 payable in advance semiannually (January 1 and July 1), plus $2,000 semiannually for executory costs. The equipment had an estimated life of 15 years and sold for $533,025 with an estimated unguaranteed residual value of $80,000. The implicit interest rate is 12 percent.
Prepare all journal entries for 2011 on Farewell's and Norman's books. Round all calculations to the nearest dollar. Use straight-line depreciation.

Question 65

On July 1, 2011, Hawkeye Aviation leased two helicopters from Honnicutt Aircraft for an initial period of 12 months with a provision for a continuation on a month-to-month basis. The lease is properly classified as an operating lease. Lease payments are to be made as follows:

After the first year, the rent continues at $6,000 per month. Provide the entries required to record the lease payments for the first year on the books of

Question 66

Washington Financing, Inc. purchased a packing machine to lease to Puyallup Fruits. The lease qualifies as a direct financing lease and requires lease payments of $58,860 per year, payable in advance, over a ten-year period. There is no expected residual value. The fair market value of the packing machine is $330,000--the same amount paid by Washington to purchase the asset. The lease term begins on January 1, 2011.
Provide the journal entries required on Washington's books to

Question 67

Roscoe Company entered into a lease of special equipment to Mac Company. The lease term was six years. The equipment cost Roscoe $40,000 and Roscoe plans to earn a $4,000 dealer profit. Roscoe's implicit rate on the lease is 12 percent.
As a result of this agreement, Roscoe will receive year-end lease payments of

A) $7,333.
B) $8,213.
C) $10,702.
D) $12,090.

Question 68

Johnson Manufacturing entered into a noncancelable lease for an office building on January 1, 2011. The lease calls for payments of $24,000 a year for eight years. The first payment is due on January 1, 2011, with the other payments due on December 31 of each year. Johnson has an incremental borrowing rate of 8 percent. The building is amortized by Johnson over eight years using the straight-line method and assuming no salvage value.
Prepare a partial balance sheet for Johnson for the year ending December 31, 2011, disclosing the asset and the liability related to the leased building.

Question 69

Standard Distributing entered into a leasing agreement with R & D Rental. The lease qualifies as a capital lease and calls for payments of $5,000 for 5 years with the first payment being made on January 1, 2011, and subsequent payments being made on December 31 of each year. Standard's incremental borrowing rate is 12 percent.
Prepare a schedule amortizing Standard's lease obligation.

Question 70

Which of the following is true regarding the deferral of sale profits on a sale-leaseback under IAS 17, "Accounting for Leases?

A) Any profit on a sale-leaseback resulting in an operating lease is deferred and recognized over the subsequent lease period, whereas any loss is recognized immediately.
B) Both profits and losses on a sale followed by an operating lease leaseback are recognized immediately if the transaction is established at fair value.
C) Profit from the sale should be deferred and amortized in proportion to the amortization of the leased asset if a capital lease results from the sale-leaseback.
D) Profit from the sale should be amortized in proportion to the rental payments it an operating lease results from the sale-leaseback.

Question 71

Business leasing has become a large market. Banks, other lending institutions, and commercial leasing companies represent the largest share of the business leasing market with the remainder consisting of manufacturers, dealers, and distributors.
Identify the advantages and disadvantages to lessors of leasing rather than selling
property.

Question 72

Garrison leased a special crane to Keillor that cost Garrison $40,000. The lease term was six years and the annual rentals were $10,000 per year, payable at the end of each year. The implicit interest rate was 10 percent. Garrison recognized a gross margin of

A) $3,553.
B) $4,000.
C) $20,000.
D) $24,000.

Question 73

On January 2, 2011, the Wilcox Studios leased six computers for use in the engineering department. The lease period is for 13 years and the estimated economic life of the leased property is 15 years. The lease does not contain automatic title transfer or a bargain purchase option. Lease payments are $9,000 per year, payable each December 31. The incremental borrowing rate for Wilcox is 12 percent and the implicit interest rate (known by Wilcox) is 10 percent. The company uses straight-line depreciation for this type of equipment.
Provide the necessary journal entries to record the transactions for Wilcox for the period January 2, 2011 through December 31, 2012.

Question 74

Henri Retail Stores is negotiating three leases for store locations. Henri's incremental borrowing rate is 12 percent. Each store will have an economic useful life of 30 years. Lease payments will be made at the end of each year. Based on the data below, properly classify each of the leases as an operating lease or a capital lease. The purchase price for each property is listed as an alternative to leasing.

Determine whether each of the leases should be classified by Henri as an operating lease or a capital lease. Show computations and reasons to support your answers.

Question 75

On January 1, 2011, Franklin Industries leased equipment on an eight-year term at $15,000 annual rental payments, paid in advance. There is a bargain purchase option on December 31, 2018 (end of lease), of $24,000. The economic life of the equipment is estimated to be 15 years. The interest rate is 12 percent.

Question 76

On January 1, 2011, R. L. Bowman, owner of Dick's Market, sold the building the store currently occupies to Adams Investing Company for the current market value of the building of $9,000,000. Prior to the sale, the carrying value of the building was $7,000,000. The estimated remaining useful life of the building is 10 years, with no residual value at that time. Straight-line depreciation is used to depreciate the building.
On the same day as the sale, January 1, 2011, Bowman signed a 10-year noncancelable leaseback agreement that has a 15 percent implicit rate of return for the lessor. The lessee's incremental borrowing rate also is 15 percent. Annual payments begin on January 1, 2011. During 2011, Bowman will pay $10,000 executory costs if the transaction qualifies as a direct-financing lease. If the agreement qualifies as an operating lease, this $10,000 will be paid by the buyer-lessor. For convenience, provide all amounts in your solution in $000.
Required:

Question 77

Spartan Corporation has entered into a debt agreement that restricts its debt-to-equity ratio to less than two-to-one. The corporation is planning to expand its facilities, creating a need for additional financing. The board of directors is considering leasing the additional facilities but is concerned that leasing may violate its existing debt agreement. A violation of the debt agreement would place the corporation in default. The potential lessor insists that the lease be structured in such a way that it can be accounted for as a capital lease by the lessor (the lessor is a dealer and wants to recognized the dealer's gross profit on the transaction immediately). In addition, the lessor requires that the residual value of the leased asset be guaranteed when it reverts to the lessor at the end of the lease term. Spartan's board has asked you to analyze the following alternative:
Alternative 1--Spartan would enter into a lease that qualifies as a capital lease (to Spartan). If this alternative is selected, Spartan's reported debt-to-owners'-equity ratio would be 1.9, and its ability to issue debt in the future would be seriously constrained.
Alternative 2--Spartan would enter into a lease and pay a third party to guarantee the residual value of the leased property. The lease would be structured in such a way as to qualify as an operating lease to Spartan and as a capital lease to the lessor. In this case, Spartan's reported debt-to-equity ratio would be unaffected by the lease contract.
Required:
Explain the consequences of each of these alternatives, including any ethical considerations that might exist.

Question 78

GW Company operates a large regional railway system. The following is an excerpt from the company's 2010 annual report:
6. Lease Commitments
GW is committed under long-term lease agreements, which expire on various dates through 2082, for equipment, rail lines, and other property. Future minimum lease payments are as follows:

Required:
Given that lease payments occur evenly throughout the year, estimate the decline in the capital lease liability in 2010.

Question 79

George Harmon is the president of the Utah Western Railroad Company. The Utah Western is a bridge line that receives traffic from the Union Pacific Railroad and the Burlington Northern railroads at Salt Lake City, Utah, and hauls the freight to Denver, Colorado, for connections with other lines to points east. Recently, traffic on the Utah Western has increased dramatically and the railroad is in need of additional locomotives to haul its trains. Accordingly, George is considering leasing locomotives to meet the demands of this increase in traffic until new engines can be ordered if the surge subsides. As the controller of the railroad, George has asked you to advise him as to the disadvantages associated with leasing generally.

Question 80

Current generally accepted accounting principles do not require operating leases to be shown on the balance sheet. Consider the case of Company
A. If the operating leases of A Company were added to the company's liabilities at December 31, 2011, the company's current ratio would decline from 0.69 to 0.57 and total debt would increase from $239 million to $1,105 million. Significant changes would also occur in the return on assets since assets would be increased and the related increase in depreciation and interest expense would exceed the rent expense currently included in the company's income statement.
Required: