Question 1

Operating leases appear as assets on the lessee's balance sheet.

Accepted Answer

Operating leases do not appear on the lessee's balance sheet. An operating lease is considered a form of off-balance-sheet financing for the lessee. The company merely footnotes their existence and key details in the annual report. Lease payments are reported as rent expense on the lessee's income statement.

Question 2

Failure to capitalize leases has very little effect on a company's return on equity (ROE) ratio.

Accepted Answer

ROE is largely unaffected since net income and stockholders' equity are largely unaffected.

Question 3

The defined contribution plan and the defined benefit plan both recognize pension expense at the accrual of the liability.

Accepted Answer

For defined contribution plans, the company records the expense at the time the liability is accrued. For defined benefit plans, the obligation is not satisfied until paid; companies are only required to report the net pension liability on the balance sheet.

Question 4

The increase in pension obligation due to an employee working an additional year for the employer will cause the net pension liability on the balance sheet to increase but have no direct effect on the income statement.

Accepted Answer

Profit will decline due to additional pension expense. The pension obligation also increases due to an increase in service and interest costs, both components of pension expense.

Question 5

Leases are often a better financing vehicle than traditional bank loans because leases often require less equity investment.

Accepted Answer

Leases generally require less up-front investment than traditional loan financing.

Question 6

Failure to recognize leases as capital leases rather than operating leases results in understated profit for a company in the early year's a lease.

Accepted Answer

Failure to capitalize leased assets and liabilities understates net operating profit because the entire lease payment is deducted as an expense under operating leases instead of only depreciation expense.

Question 7

Operating leases increase interest expense in the income statement, while decreasing net cash flows in the cash flow statement, compared with capital leases.

Accepted Answer

Operating leases record rent expense, rather than interest and depreciation. Further, the lease payments (e.g., cash outflows) are the same, whether or not the lease is capitalized.

Question 8

GAAP permits companies to choose to report pension income based either on actual investment returns of pension investments or on expected returns.

Accepted Answer

GAAP requires companies to report pension income based on the expected return of the pension investment. The aim is to stabilize long-term returns instead of reporting annual or quarterly swings due to the fluctuation in the market.

Question 9

Companies are required to report total pension assets and total pension liabilities on their balance sheets.

Accepted Answer

Companies are required to report only the funded status, the net pension asset or liability, on their balance sheets.

Question 10

Off-balance-sheet financing instruments are not reported on the financial statements or the footnotes to those statements.

Accepted Answer

Although not reported on the face of the financial statements, GAAP requires detailed footnote disclosures for off-balance-sheet financing.

Question 11

IFRS classifies more leases as finance leases that are reported on the balance sheet than those capitalized under U.S. GAAP.

Accepted Answer

IFRS is principles based which classifies more leases as capital leases, called finance leases under IFRS. Both U.S. GAAP and IFRS require that leases be capitalized when the leased asset's risks and rewards are transferred to the lessee.

Question 12

Both IFRS and U.S. GAAP require companies to report the funded status of defined benefit pension plans on the balance sheet.

Accepted Answer

Companies must report the funded status of defined benefit pension plans on the balance sheet under both GAAP and IFRS. The IFRS' calculation of the unfunded status differs from that under GAAP.

Question 13

How are operating leases reported in the lessee's financial statements?
I. As an asset that is depreciated, similar to the company's other assets
II. As a footnote disclosure
III. As either a short-term or long-term liability, depending on the length of the lease

Accepted Answer

Operating leases are not reported on a company's balance sheet. They are noted in the footnotes to the financial statements, which provide key details regarding the company's current and future lease payment obligations.

Question 14

GAAP identifies two different approaches in reporting leases by the lessee: capital lease method and the operating lease method.
Which option best describes the financial statement effects of leasing on the financial statements of the lessee?

Accepted Answer

No assets or liabilities are recorded for operating leases. The payment is recognized as rent expense. Under capital leases, an asset is capitalized and depreciated, and a liability is recorded which creates interest expense.

Question 15

Which of the following is not a factor that changes a company's pension obligation during the year?

Accepted Answer

Options A, B, and C all affect a company's pension obligation. Investment returns and contributions affect the pension fund, but not the obligation to employees.

Question 16

Which of the following is not a benefit of utilizing operating leases for the lessee?

Accepted Answer

NOPAT is lower with operating leases, as all of the rent payments are classified as an operating expense. With capital leases, a portion of the payment is classified as nonoperating interest expense. All other choices are benefits of operating leases for the lessee.

Question 17

Failure to capitalize leased assets and liabilities when they should be capitalized results in a number of distortions in the ROE disaggregation analysis.
Which of the following is not a distortion?

Accepted Answer

Reported expense is higher in the early years of a capital lease relative to an operating lease, but is lower in later years. Capital leases report depreciation (operating) expense and interest (nonoperating) expense; whereas, operating leases report rent (operating) expense only.

Question 18

Festival Corp. disclosed the following lease information in its 2016 annual report (in millions).
 What lease liability does Festival's report on its balance sheet at December 31, 2016?

Accepted Answer

The present value of capital leases is reported on the balance sheet.

Question 19

Which of the following is a requirement under IFRS but not under U.S. GAAP?

Accepted Answer

Answers A, C, and D are required under both GAAP and IFRS.

Question 20

Rosebud Corp. reported the following items in the 2016 pension footnote.
 How much is the company's pension expense for the year?

Accepted Answer

Pension Expense = Service cost + Interest cost + Amortization of deferred amounts - Expected return on pension plan assets
= $1,610 + $780 + $62 ? $1,200 = $1,252

Quiz 10: Reporting and Analyzing Leases, Pensions, and Income Taxes