Ch 21

Question 1

What is a lease?

Answer 1

A contractual agreement between lessor and a lessee

Question 2

What does a lease give the lessee the right to?

Answer 2

The right to use specific property that is owned by lessor for a specified period of time

Question 3

In exchange for the right to use lessors asset, what does the lessee do?

Answer 3

Makes rental payments over lease term to lessor

Question 4

Who are the largest players in the leasing business?

Answer 4

Banks

Question 5

What are captive leasing companies?

Answer 5

They are subsidiaries whose primary business is to perform leasing operations for a parent company

Question 6

What are the 6 advantages of leasing?

Answer 6

1. 100% financing at fixed rates
2. Protection against obsolescence
3. Flexibility
4. Less costly financing
5. Tax advantages
6. Off balance sheet financing

Question 7

What are the views on capitalization of leases?

Answer 7

1. Do not capitalize any leased assets
2. capitalize leases that are similar to installment purchases
3. Capitalize all long term leases
4. Capitalize form leases where penalty for nonperformance is substantial

Question 8

operating leases should be capitalized.

True or false?

Answer 8

False, companies should account for them as rental payments and receipts

Question 9

In order to record a lease As a capital lease, what kind of lease must it be?

Answer 9

Noncanceable

Question 10

What are the 4 criteria’s for the capitalization of a lease. (Lessee)

Answer 10

1. Lease transfers ownership of property to lessee
2. Contains bargain purchase option
3. Lease term is equal to 75% or more of estimated economic life of leased property
4. PV of minimum lease payments (excluding executary costs) equals or is > than 90% of fair value of leased property

Question 11

Do you have to meet all criteria for a capital lease?

Answer 11

No just one or more

Question 12

What is a bargain purchase option?

Answer 12

Allows lessee to purchase leased property for a price that is significantly lower than the property’s expected FMV at the date the option becomes exerciseable

Question 13

The difference between option price and expected fair value must be large enough to make exercise of option reasonably reassured

Answer 13

Yes

Question 14

If a lease period is equal to or exceeds 75% of the assets economic life then who bares most of the risk and rewards of ownership?

Answer 14

Lessee

It is transferrd from lessor to lessee

Question 15

Lease term is generally considered as what?

Answer 15

Fixed, noncanceable term of lease

Question 16

What is a bargain renewal option?

Answer 16

Allows the lessee to renew the lease for a rental that is lower than the expected fair rental at date the option becomes exercisable

Question 17

Determine the PV of minimum lease payments involves 3 important concepts

Answer 17

1. Minimum lease payments
2. Executory cost
3. Discount rate

Question 18

Minimum lease payments include

Answer 18

1. Minimum rental payments
2. Guaranteed residual value
3. Penalty for failure to renew or extend lease
4. BPO

Question 19

What are executory costs?

Answer 19

Leased tangible assets incur insurance, maintenance, and tax expenses

Question 20

The minimum lease payments are calculated how?

Answer 20

The PV is computed of minimum lease payments using incremental borrowing rate

Question 21

If lessee knows the implicit interest rate of others and it is less than their own incremental borrowing rate then you what?

Answer 21

Use the implicit rate

Question 22

What is the interest rate implicit in the lease?

Answer 22

It is the discount rate that when applied to minimum lease payments and any ungarenteed residual value accruing to lessor causes aggregate PV to equal FV of lease property to lessor

Question 23

Lessee records a leased asset and a lease liability at the lower of

Answer 23

1. PV of minimum lease payments (excluding executory costs)

OR

2. FV of leased asset at inception of lease

Question 24

If there is a transfer of ownership or contains BPO, how is the asset depreciated?

Answer 24

Over economic life of asset

Question 25

If there is no owner transfer or no BPO, how is asset depreciated?

Answer 25

It is depreciated over term lease

Question 26

What is the effective interest method used to allocate?

Answer 26

Each lease payment between principal and interest

Question 27

What does the effective interest method produce?

Answer 27

A periodic interest expense that is equal to a constant % of CV of lease obligation

Question 28

When using effective interest method to capital leases, what discount rate must be used?

Answer 28

The same discount rate must be used as the discount rate that determines PV of minimum lease payments

Question 29

FASB requires lessees and lessors to disclose certain information about leases in FS or in notes. This includes

Answer 29

1. General description of nature of leasing arrangements 2. Nature timing and amount of cash in and outflows associated with leases including payments to be paid or recieved for each of five succeeding years 3. Amt of lease rev and exp reported in IS each period 4. Descript and amount of leased assets by major balance sheet classification and related liabilities 5. Amounts receievale and unearned rev under lease agreements