Chapter 21

Question 1

What is a lease?

Answer 1

contractual agreement between the lessor and lessee

Question 2

What right does the lease give to the lessee?

Answer 2

the right to use specific property

Question 3

What does the lease specify?

Answer 3

the duration of the lease and rental payments

Question 4

Who assumes the obligations for taxes, insurance, and maintenance?

Answer 4

The lessor or lessee

Question 5

Who is the lessee?

Answer 5

the temporary user of an asset

Question 6

Who is the lessor?

Answer 6

the titleholder and true owner of the property

Question 7

What are the advantages of leasing?

Answer 7

1) Leases may not require any money down, 2) Lease payments are often fixed, 3) Leases reduce the risk of obsolescence to the lessee (don’t want to be stick with older model), 4) Leases may contain less restrictive covenants than other types of lending arrangements, 5) Leases may be a less costly means of financing, 6) Certain leases may not add to existing debt on the balance sheet

Question 8

What kind of balance sheet item are leases?

Answer 8

off-balance sheet items

Question 9

According to the FASB, when should a lease be capitalized?

Answer 9

when a lease transfers substantially all of the benefits and risks of ownership

Question 10

According to the FASB, when can transfer of ownership be assumed?

Answer 10

only if there is a high degree of performance to the transfer, that is, the lease is non-cancelable

Question 11

According to the FASB, what are operating leases?

Answer 11

leases that do not substantially transfer benefits and risks and can be cancelled

Question 12

Which standard applies to leases?

Answer 12

SFAS 13

Question 13

What is the effect on assets and liabilities when a lease is capitalized?

Answer 13

debit asset and credit liability

Question 14

What is the effect is a lease is classified as operating?

Answer 14

debit rent expense

Question 15

What are the four criteria for classifying a lease as a capital lease?

Answer 15

1) Leases transferring ownership, 2) Leases with bargain purchase options, 3) Leases with lease terms equal to 75% or more of the economic life (75% rule), 4) Leases where the present value of lease payments is equal to 90% or more of the fair market value (90% rule)

Question 16

How many criteria must a lease meet in order to be capitalized?

Answer 16

One

Question 17

What type of accounting bases does the lease standard follow?

Answer 17

Bright-line accounting

Question 18

In what order does the evidence for capitalization of leases go?

Answer 18

Strongest to weakest, with 1 being the strongest and 4 being the weakest

Question 19

Which two principles of lease accounting are non-controversial and are similar between IFRS and GAAP?

Answer 19

the first two principles

Question 20

Why are the first two principles of lease accounting non-controversial?

Answer 20

1) If it says anywhere that there will be a transfer of title, is a transfer of ownership, no matter when the transfer occurs, 2) If option is to purchase for less than FV, then will probably be exercised

Question 21

How do you determine the value of a bargain purchase option?

Answer 21

Compare purchase prices at end to FV (10% less than FV)

Question 22

Which two principles of lease accounting are controversial?

Answer 22

the last two principles

Question 23

Why are the last two principles controversial?

Answer 23

1) no rounding, calculations must be exact, 2) life of the asset can change, 3) what discount rate to use, 4) what really is fair value, 5) where do percentages come from

Question 24

What does the GAAP method of accounting for leases allow companies to do?

Answer 24

manipulate around standards so don’t have to capitalize leases

Question 25

How does IFRS differ from GAAP?

Answer 25

IFRS does not specify percentages that must be used for last two principles and uses judgement and principles-based accounting

Question 26

What is the lessee entry in a capital lease transaction?

Answer 26

records asset and liability

Question 27

What is the lessee required to do with the with the asset?

Answer 27

depreciate it over the economic life of the asset

Question 28

What is the lessee required to do with the rental payments?

Answer 28

allocate them between principal and interest

Question 29

What method is used to allocate rental payments?

Answer 29

the effective interest method

Question 30

Are depreciation of the asset and discharge of the lease similar accounting procedures?

Answer 30

no, independent accounting procesudures

Question 31

What are the 3 levels of lessor lease classification?

Answer 31

1) Operating lease, 2) Direct financing lease, 3) Sales-type lease

Question 32

How does IFRS say lessors must classify leases?

Answer 32

Operating or direct financing

Question 33

What is the lessee process for recording a lease

Answer 33

1) Debit asset and credit liability, 2) Depreciate asset, 3) Set up to determine interest, 4) Determine what it's really worth compared to what discharge is

Question 34

What criteria must be met in order for a lessor to classify a lease as an operating lease?

Answer 34

1) The lease does not meet any group 1 criteria (same as lessee's) OR 2) Collectibility of payments isn't reasonably assured OR 3) Lessor's performance isn't substantially complete

Question 35

What is used to determine the collectibility of payments

Answer 35

the revenue recognition principle and the lessor will check the party's ability to pay

Question 36

When is a lessor's performance not complete?

Answer 36

if the lessor is still responsible for maintenance

Question 37

What criteria must be met in order for a lessor to classify a lease as a direct financing lease?

Answer 37

Lease must meet group 1 criteria (same as lessee's), and the following group 2 criteria: 1) Collectibility of payments must be reasonably assured, AND 2) Lessor's performance must be substantially complete, AND 3) Asset's fair value must be equal to lessor's book value

Question 38

Can a lessee and lessor classify leases differently?

Answer 38

Yes

Question 39

What biases are present amongst lessors and lessees?

Answer 39

Lessor biased toward operating leases while lessee is biased toward capitalized leases

Question 40

What information is needed by the lessor to record a direct financing lease?

Answer 40

lease investment (lease receivable), consisting of the minimum lease payments and any residual value at the end of the lease term

Question 41

What determines the residual value?

Answer 41

the nature of the asset

Question 42

What information is needed by the lessor to record a sales lease?

Answer 42

Lease receivable plus sales (equal to lease receivable) and COGS (equal to asset book value)

Question 43

What statements do sales and lease receivable appear on?

Answer 43

Sales - Income Statement, Lease Receivable - Balance Sheet

Question 44

Why are sales leases most beneficial for the lessor?

Answer 44

Because they make a profit on sale and ongoing profits through interest revenue

Question 45

What is a residual value?

Answer 45

the estimated fair value of an asset at the end of the lease term

Question 46

What are the two types of residual values?

Answer 46

Guaranteed or Unguaranteed

Question 47

Does a lessor care is a residual value is guaranteed or not?

Answer 47

do not care after the lease rate is determined

Question 48

Do lessee's care if a residual value is guaranteed or not?

Answer 48

Yes, guaranteed residual values affect the minimum lease payment calculations and unguaranteed residual values do not

Question 49

What is the difference between a guaranteed and unguaranteed residual value?

Answer 49

Guaranteed: what part you are staking, Unguaranteed: kind of nebulous

Question 50

What are executory costs?

Answer 50

Maintenance and extra costs

Question 51

What is an annuity due?

Answer 51

When interest payments are made at the beginning of the year

Question 52

How is residual value treated in regards to depreciation?

Answer 52

residual value is seen as the salvage value but is not subtracted when it is not included within the asset value and only depreciate for term of lease

Question 53

How does strong vs. weak criteria effect depreciation?

Answer 53

When strong evidence is used, use the entire asset life and strong vs. weak only changes years of depreciation

Question 54

What indicates if the collection of payments is reasonably uncertain?

Answer 54

If says have liquidity concerns or payment problems

Question 55

What is the main difference between sales type and direct financing leases?

Answer 55

Sales type leases are presented on the income statement in the form of COGS and sales, while direct financing leases are not

Question 56

What journal entry occurs if the equipment leased out is taken back and not purchased?

Answer 56

Debit equipment and credit lease receivable