Question 1

A leveraged lease is a lease under which the lessee sells an asset for cash to a prospective lessor and then leases back the same asset, making fixed periodic payments for its use.

Accepted Answer

In a leveraged lease, a lessor buys an asset with borrowed funds and then leases the asset to a lessee. The lessee does not sell the asset to the lessor in this arrangement.

Question 2

An operating lease need not be capitalized, but its basic features must be disclosed in a footnote to the financial statements.

Accepted Answer

This is true. An operating lease is not required to be capitalized and instead is accounted for as a rental expense. However, the basic details of the operating lease must be disclosed in a footnote to the financial statements according to accounting standards.

Question 3

If a lease meets any of the FASB Standard No. 13 criteria, it should be shown as a capitalized lease, meaning the present value of all its payments should be included as an asset and corresponding liability on the firm's balance sheet.

Accepted Answer

FASB Standard No. 13 requires leases that meet certain criteria (such as transfer of ownership, bargain purchase option, or lease term greater than 75% of the asset's economic life) to be shown as capitalized leases on the balance sheet, with the present value of all lease payments included as both an asset and corresponding liability.

Question 4

When a firm becomes bankrupt or is reorganized, the maximum claim of lessors against the corporation is three years of lease payments.

Accepted Answer

According to the Bankruptcy Code, 11 U.S.C. § 502(b)(6), the maximum claim of lessors against the corporation is three years of lease payments in the event of bankruptcy or reorganization.

Question 5

At the end of the term of the lease agreement, the salvage value of an asset, if any, is realized by the lessee.

Accepted Answer

The salvage value of an asset at the end of a lease agreement is typically realized by the lessor, not the lessee, unless specified otherwise in the lease terms.

Question 6

A ________ is normally initiated by a firm that needs funds for operations. An asset previously owned by a lessee is sold to the lessor.

Accepted Answer

A sale-leaseback is a transaction in which a company sells its owned asset to a lessor and then immediately leases it back for a set period of time. This allows the company to generate funds while still retaining use of the asset. It is a form of leasing that provides the benefits of ownership without the burden of ownership.

Question 7

Assets leased under ________ leases generally have a usable life longer than the term of the lease.

Accepted Answer

Operating leases are typically used for assets with a shorter useful life than the term of the lease, while capital leases are used for assets with a longer useful life. Financial and direct leases are not commonly used lease types. Therefore, the correct choice is B (operating leases).

Question 8

________ lease is a contractual arrangement whereby the lessee agrees to make periodic payments to the lessor for five or fewer years for an asset's services. This type of lease may also be canceled at the option of the lessee.

Accepted Answer

An operating lease is a type of lease where the lessee pays periodic payments to the lessor for the use of an asset for a period of five or fewer years. This type of lease is cancelable at the option of the lessee, and the lessor retains ownership of the asset. It is often used for assets that have a shorter useful life, such as computers or office equipment.

Question 9

Leasing allows the lessee, in effect, to depreciate land, which is prohibited if the land were purchased.

Accepted Answer

Leasing allows the lessee to claim depreciation expenses on the land, which is prohibited if the land were purchased as it is not a depreciable asset.

Question 10

Renewal options are provisions frequently included in both operating and financial leases that allow the lessee to purchase the leased asset at maturity.

Accepted Answer

Renewal options allow the lessee to extend the lease term for a specified period, not to purchase the leased asset. Purchase options, if included, specifically grant the right to buy the asset at maturity.

Question 11

One disadvantage of leasing is that in many cases, the return to the lessor is quite high so the firm in need of the asset might be better off borrowing to purchase it.

Accepted Answer

Leasing often includes a high rate of return for the lessor, which can make purchasing the asset a better financial decision for the lessee.

Question 12

A capital or capitalized lease is otherwise known as

Accepted Answer

A capital or capitalized lease is also known as a financial lease. In this type of lease, the lessee (the person leasing the asset) takes on the responsibility of ownership and typically has a purchase option or obligation at the end of the lease term. It is different from an operating lease, which is a shorter-term lease where the lessor (the owner of the asset) remains responsible for ownership and maintenance of the asset. Direct leases and leveraged leases are also types of leases but do not necessarily refer specifically to capitalized leases.

Question 13

Since operating leases result in the receipt of services from an asset without increasing the assets or liabilities on the firm's balance sheet, leasing may result in misleading financial ratios.

Accepted Answer

Operating leases are off-balance sheet financing, which means a company can receive services from an asset without reporting the asset or related liability on its balance sheet. This can make a company's financial ratios appear better than they actually are, making it a potential source of financial misrepresentation.

Question 14

Renewal options normally require the lessor to maintain the assets and to make insurance and tax payments.

Accepted Answer

Renewal options typically pertain to the terms under which the lessee can extend the lease period, not the responsibilities of the lessor regarding maintenance, insurance, and tax payments, which are usually outlined separately in the lease agreement.

Question 15

One advantage of leasing is that in many cases, the return to the lessor is quite high so the firm in need of the asset might be better off borrowing to purchase it.

Accepted Answer

The statement is incorrect. The advantage of leasing is that the lessee can acquire and use the asset without making a large upfront payment, and the lessor typically bears the risks associated with ownership such as maintenance and obsolescence. However, leasing can be more expensive in the long run compared to purchasing the asset outright.

Question 16

A capitalized lease is a financial lease that has the present value of all its payments included as an asset and corresponding liability on the firm's balance sheet.

Accepted Answer

This accurately describes a capitalized lease.

Question 17

Purchase options are provisions frequently included in both operating and financial leases that allow the lessee to purchase the leased asset at maturity.

Accepted Answer

Purchase options are commonly included in leases, giving the lessee the option to buy the asset at the end of the lease term. This can be found in both operating and financial leases.

Question 18

In a financial lease, the lessor must receive more than the asset's purchase price in order to earn its required return. However, in an operating lease, the total payments made by the lessee to the lessor are generally less than the lessor's initial cost of the leased asset.

Accepted Answer

In a financial lease, the lessor receives payments that cover the cost of the asset plus interest and other charges, resulting in a return on investment.

Question 19

Maintenance clauses are provisions normally included in an operating lease that require the lessor to maintain the assets and to make insurance and tax payments.

Accepted Answer

Maintenance clauses are typically included in operating leases to ensure that the lessor is responsible for maintaining the leased assets and making payments for insurance and taxes.

Question 20

Renewal options are provisions normally included in an operating lease that grant the lessee the right to re-lease assets at the expiration of the lease.

Accepted Answer

Renewal options are typically included in operating leases as a way for the lessee to continue using the leased assets after the initial lease term has expired.

Quiz 17: Hybrid and Derivative Securities