Lease Amortization

Question 1

True or False:
A transfer of ownership of an asset from one party to another party in a contractual agreement is the definition of a lease.

Answer 1

False
Transfer of ownership can be written but is not necessary.

Question 2

True or False:
Leasing gives protection against obsolescence for the lessor which is considered an advantage.

Answer 2

False
This is an advantage for the lessee.

Question 3

True or False:
The FASB has adopted the approach that all leases should be capitalized.

Answer 3

False

Question 4

True or False:
In an operating lease, the lessor recognizes interest expense on the lease liability using the effecitve inte4rest method over the useful life of the asset and records the amortization expense on the right of use asset on a straight line basis.

Answer 4

False
This is for a finance lease.

Question 5

True or False:
The presence of a bargain purchase option is the only criteria considered by the lessee to decide whether to classify and account for the arrangement as a finance lease.

Answer 5

False

Question 6

True or False:
Companies should use the finance method in accounting for the lease transaction when the lease term is equal to or greater than 75% of the remaining economic life of the economic asset.

Answer 6

True

Question 7

True or False:
Under the present value test, the FASB uses 90% as the guideline to determine if the present value of the lease payments is reasonably close to the fair value of the asset’s guaranteed residual value.

Answer 7

False

Question 8

True or False:
When valuing the lease liability, the lessee should include lease payments in the value of lease liability at the level of the index or rate at the commencement date and should expense any future differences in the lease payments due to changes in the index or rate when incurred.

Answer 8

True

Question 9

True or False:
The lessee includes the full amount of a guaranteed residual value at the end of the lease term for the present value test and to capitalize lease liability,

Answer 9

False
When calculating minimum lease payments for the present value test, the full amount of residual value is included, while when calculating minimum lease payments to capitalize lease liability, only the excess of the guaranteed residual value over the expected residual value is included in the calculation.

Question 10

True or False:
When determining the present value test, when both the implicit rate and the incremental borrowing rate are presented, the lessee can use both rates in determining the amount to report as the asset and related liability.

Answer 10

False
When determining the present value test, the lessee should use the implicit interest rate, while when it’s impractical to find the implicit interest rate, the lessee may use the incremental borrowing rate.

Question 11

True or False:
The lease classification test for the lessor differs from the tests used by the lessee to determine the classification of a lease as a financing or operating lease under the present value test.

Answer 11

False

Question 12

True or False:
Under an operating lease, the lessor records a lease revenue in each period and retains the leased asset on its balance sheet.

Answer 12

True

Question 13

A lease conveyance is described by all of the following except:

a. lessor conveys less than his or her total interest in property
b. a transfer of control of an asset to the lessee
c. a transfer of ownership from one party to another
d. a lessor agrees to transfer the ROUA to the lessee

Answer 13

c. a transfer of ownership from one party to another

Question 14

Which of the following is one of the advantages of leasing for the lessee?

a. it often provides profitable interest margins
b. residual values at the end of the lease can sometimes provide large profits
c. leasing improves financial ratios by increasing assets without corresponding increase in debt
d. lease agreements may contain less restrictive provisions than other debt agreements

Answer 14

d. lease agreements may contain less restrictive provisions than other debt agreements

Question 15

​Which of the following is considered one of the commonly discussed advantages of a lease for the lessor?

a. It can provide a high residual value to the lessor upon return of the property.
b. Leasing permits 100% financing at fixed rates.
c. Leasing permits changes in equipment more easily thus reducing the risk of obsolescence.
d. The control over the leased assets remains with the lessor since the lessor is still the owner of the asset.

Answer 15

a. It can provide a high residual value to the lessor upon return of the property.

Question 16

Which of the following approaches of the capitalization of leases has been adopted by the FASB?

a. Capitalize all leases.
b. Capitalize firm leases where the penalty for nonperformance is substantial.
c. Do not capitalize any leased assets.
d. Capitalize all long-term leases.

Answer 16

d. Capitalize all long-term leases.

Question 17

​All of the following lease arrangements may be accounted for as an operating lease by the lessee, except:

a. The present value of the minimum lease payments is $48,500 and the fair value of the leased property is $70,000.
b. The lease agreement term is 3 years and the economic life of the leased property is 4 years.
c. The lessee is given the option to renew the agreement.
d. The lease contains no renewal options.

Answer 17

b. The lease agreement term is 3 years and the economic life of the leased property is 4 years.

Question 18

​All of the following lease arrangements should be accounted for as a finance lease by the lessee except:

a. The lease agreement allows the lessee the right to purchase the leased asset of fair market value of $68,000 at a price of $6,000 at the end of the lease term.
b. The present value of the minimum lease payments is $23,900 and the fair value of the leased property is $25,200.
c. The lessee enters into a two-years agreement to lease a brand new truck of a ten years useful life.
d The lease agreement term is 8 years and the economic life of the lease property is 10 years.

Answer 18

c. The lessee enters into a two-years agreement to lease a brand new truck of a ten years useful life.

Question 19

​The lessee should compute the present value of the payments under the present value test using the lessor’s implicit interest rate, or:

a. The incremental borrowing rate when it is double the implicit rate.
b. If the implicit interest rate is not known, the agreement will be cancelled.
c. The incremental borrowing rate upon the lessor’s request.
d. The lessee’s incremental borrowing rate when the lessor implicit rate can’t be determined.

Answer 19

d. The lessee’s incremental borrowing rate when the lessor implicit rate can’t be determined.

Question 20

​Woody Company has a machine with a cost and fair market value of $385,000 on the date the machine is leased to Bulk Company.

The lease is for 10 years and the machine is estimated to have no residual value. If the lessee incremental borrowing rate is 10% and the lessor’s implicit interest rate is 8%, the Present Value of an Annuity Due of 1 at 10 periods at 10% and 8% yield factors of 6.7590 and 7.2469 respectively, the ten beginning-of-the-year lease payments would be:

a. $56,961.09
b. $57,376.19
c. $53,126.16
d. $57,065.78

Answer 20

c. $53,126.16

Question 21

Karl Corporation signed a noncancelable lease for a specialized machinery on January 1, 2018 for five years, Karl should make annual payments of $40,000 at the beginning of each year for five years with the title passing to Karl at the end of this period. The machinery has an estimated useful life of 6 years and no guaranteed residual value. Karl uses the straight-line method of depreciation for all of its fixed assets. Karl accordingly accounts for this lease transaction as a finance lease. The present value of the lease payments was determined to be $185,196 at an implicit interest rate of 4%. The entry to record the lease on Karl books includes:

a. a debit to Deferred Lease Expense of $14,804
b. a debit to Right-of-Use Asset of $200,000
c. credit to Lease Liability of $185,196
d. debit to Lease Liability of $185,196

Answer 21

c. credit to Lease Liability of $185,196

Question 22

Karl Corporation signed a noncancelable lease for a specialized machinery on January 1, 2018 for five years, Karl should make annual payments of $40,000 at the beginning of each year for five years with the title passing to Karl at the end of this period. The machinery has an estimated useful life of 6 years and no guaranteed residual value. Karl uses the straight-line method of depreciation for all of its fixed assets. Karl accordingly accounts for this lease transaction as a finance lease. The present value of the lease payments was determined to be $185,196 at an implicit interest rate of 4%. For the year ended 2018, Karl should record:

a. lease expense of $40,000
b. Lease receivable of $5,807.84 and depreciation expense of $30,866
c. interest expense of $7,407.84 and lease expense of $40,000.00
d. Interest expense of $5,807.84 and depreciation expense of $30,866

Answer 22

d. Interest expense of $5,807.84 and depreciation expense of $30,866

Question 23

Karl Corporation signed a noncancelable lease for a specialized machinery on January 1, 2018 for five years, Karl should make annual payments of $40,000 at the beginning of each year for five years with the title passing to Karl at the end of this period. The machinery has an estimated useful life of 6 years and no guaranteed residual value. Karl uses the straight-line method of depreciation for all of its fixed assets. Karl accordingly accounts for this lease transaction as a finance lease. The present value of the lease payments was determined to be $185,196 at an implicit interest rate of 4%. For the year ended 2020, Karl should record:

a. Interest expense of $4,440.15 and depreciation expense of $30,866
b. interest expense of $3,017.76 and depreciation expense of $30,866
c. interest expense of $3,017.76 and depreciation expense of $92,598
d. Interest expense of $7407.84 and depreciation expense of $30,866

Answer 23

b. interest expense of $3,017.76 and depreciation expense of $30,866

Question 24

​ In accounting for sales-type lease, when payments by the lessee are determined as not probable, then

a. Both parties record the lease as an operating lease.
b. The lessor records a receivable and derecognizes the leased asset and makes a disclosure as to the improbability of payments.
c. The lessor does not record a receivable and does not derecognize the leased asset, and the lease agreement is canceled.
d. The lessor does not record a receivable and does not derecognize the leased asset, but instead records any receipt of lease payments as a deposit liability.

Answer 24

d. The lessor does not record a receivable and does not derecognize the leased asset, but instead records any receipt of lease payments as a deposit liability.

Question 25

Donald Company leased equipment to Trayant Company on July 1, 2012, for a non-cancelable, ten-year period expiring June 30, 2022 (Donald and Trayant both have a year-end of December 31). Equal annual payments under the lease are $70,000 and are due on July 1 of each year. The first payment was made on July, 1 2012. The implicit interest rate contemplated by Donald and Trayant is 8%. Furthermore, the fair value of the equipment was $ 530,000 while the carrying value on Donald’s accounting records was $500,000; and there is a guaranteed residual value of $25,000 (which is less than the expected residual value of the equipment at the end of the lease). The present value factor of an annuity due of $1 at 8% is 7.24689 and the present value factor of $1 discounted at 8% is 0.46319. Donald classifies the lease as: a. Operating lease b. Sales-type lease c. Finance lease d. Direct financing lease

Answer 25

b. Sales-type lease

Question 26

Donald Company leased equipment to Trayant Company on July 1, 2012, for a non-cancelable, ten-year period expiring June 30, 2022 (Donald and Trayant both have a year-end of December 31). Equal annual payments under the lease are $70,000 and are due on July 1 of each year. The first payment was made on July, 1 2012. The implicit interest rate contemplated by Donald and Trayant is 8%. The carrying value of the equipment on Donald’s accounting records was $500,000; and there is a guaranteed residual value of $25,000 (which is less than the expected residual value of the equipment at the end of the lease). The present value factor of an annuity due of $1 at 8% is 7.24689 and the present value factor of $1 discounted at 8% is 0.46319. Trayant will recognize an amount of lease receivable of: a. $518,862.05 b. $507,282.30 c. $700,000.00 d. $0.00

Answer 26

d. $0.00 A lease receivable is not recorded by the lessor in a sales type lease

Question 27

Donald Company leased equipment to Trayant Company on July 1, 2012, for a non-cancelable, ten-year period expiring June 30, 2022 (Donald and Trayant both have a year-end of December 31). Equal annual payments under the lease are $70,000 and are due on July 1 of each year. The first payment was made on July, 1 2012. The implicit interest rate contemplated by Donald and Trayant is 8%. The carrying value of the equipment on Donald’s accounting records was $500,000; and there is a guaranteed residual value of $25,000 (which is less than the expected residual value of the equipment at the end of the lease). The present value factor of an annuity due of $1 at 8% is 7.24689 and the present value factor of $1 discounted at 8% is 0.46319. Donald records a gain of: a. $0.00 b. $18,862.05 c. $25,000.00 d. $6,137.95

Answer 27

b. $18,862.05

Question 28

Donald Company leased equipment to Trayant Company on July 1, 2012, for a non-cancelable, ten-year period expiring June 30, 2022 (Donald and Trayant both have a year-end of December 31). Equal annual payments under the lease are $70,000 and are due on July 1 of each year. The first payment was made on July, 1 2012. The implicit interest rate contemplated by Donald and Trayant is 8%. The carrying value of the equipment on Donald’s accounting records was $500,000; and there is a guaranteed residual value of $25,000 (which is less than the expected residual value of the equipment at the end of the lease). The present value factor of an annuity due of $1 at 8% is 7.24689 and the present value factor of $1 discounted at 8% is 0.46319. The interest revenue on the lease receivable recorded by Donald Company at year-end, December 31, 2012 is: a. $35,908.96 b. $20,754.48 c. $17,954.48 d. $41,508.96

Answer 28

c. $17,954.48

Question 29

True or False: For leases classified as operating, the lessee records a right of use asset and interest expense at the commencement of the lease, similar to the finance lease approach.

Answer 29

False At commencement date, the lessee records a right-of-use asset and lease liability in accounting for operating lease similar to finance lease. At the commencement date, no time has elapsed for interest to be incurred.

Question 30

True or False: When a lease is classified as an operating lease, the lessee reports interest on the lease liability as part of lease expense.

Answer 30

True

Question 31

All these statements are correct regarding a finance lease and an operating lease for a lessee, except: a. The lessee records a right-of-use asset and lease liability at commencement and uses the effective interest method to amortize the lease liability. b. In an operating lease and unlike the finance lease, the lessee does not report an amortization expense related to the right-of-use asset. c. Instead of reporting interest expense separately as is the case in a finance lease, a lessee reports interest on the lease liability as part of Lease Expense in an operating lease. d. In a finance lease and similarly to an operating lease, the lessee records a right-of-use asset and lease liability at commencement and records the same amount for lease expense each period over the lease term.

Answer 31

d. In a finance lease and similarly to an operating lease, the lessee records a right-of-use asset and lease liability at commencement and records the same amount for lease expense each period over the lease term.

Question 32

Horseshoe Company is leasing a machine from Jason Company on January 1, 20×5 and is non-cancelable with a term of five years and the payment starts from the beginning of the lease. The machine fair value at commencement is $220,000 and has an estimated economic life of ten years and an unguaranteed residual value at the end of the lease of $80,000. The lease contains no renewal options and the machine will return back to Jason at the end of the lease. The implicit rate of Jason is 6% and is known by Horseshoe. Jason determined the rental payments using the 6% rate of return. The present value factor of an annuity due of $1 at 6% for 5 years is 4.46511 and the present value factor of $1 discounted at 6% for 5 years is 0.74726. What amounts should Horseshoe record on January 1, 20×5 for the right-of-use asset and the lease liability? a. $279,780.80 b. $100,000.00 c. $160,219.20 d. $140,000.00

Answer 32

c. $160,219.20 Fair Value of the machine: $220,000.00 Less (present value of the unguaranteed residual value) $80,000 x 0.74726: ($59,780.80) $160,219.20

Question 33

Horseshoe Company is leasing a machine from Jason Company on January 1, 20×5 and is non-cancelable with a term of five years and the payment starts from the beginning of the lease. The machine fair value at commencement is $220,000 and has an estimated economic life of ten years and an unguaranteed residual value at the end of the lease of $80,000. The lease contains no renewal options and the machine will return back to Jason at the end of the lease. The implicit rate of Jason is 6% and is known by Horseshoe. Jason determined the rental payments using the 6% rate of return. The present value factor of an annuity due of $1 at 6% for 5 years is 4.46511 and the present value factor of $1 discounted at 6% for 5 years is 0.74726. How much amortization of the right-of-use asset should Horseshoe record At December 31, 20×5? a. $35,882.48 b. $0 c. $32,043.84 d. $28,422.28

Answer 33

d. $28,422.28 Since the amortization method of the ROU asset depends on the classification of the lease, the first step to solve this question is to determine whether the lease is an operating or a finance lease. Under U.S. GAAP, a lessee classifies a lease as finance if any of these criteria is met: Lease transfers ownership by the end of the lease term. Lease grants a purchase option that the lessee is reasonably certain to exercise. Lease term is for the major part (≥75%) of the remaining economic life of the asset. Present value (PV) of lease payments + residual value guarantee is substantially all (≥90%) of the fair value of the asset. The asset is so specialized that it has no alternative use to the lessor at the end of the lease. In this question: Lease term = 5 years, Economic life = 10 years ⇒ 5/10 = 50% (<75%). Present value of lease payments ≈ 73% of the $220,000 fair value (<90%). No ownership transfer, no purchase option, and no specialized asset. Hence, none of the finance-lease criteria are met ⇒ it is an operating lease for Horseshoe. The amortization of the right-of-use asset under an operating lease is equal to the annual payment minus the interest expense incurred calculated as follows: The lease liability recorded on January 1, 20×5 is the fair value of the truck ($220,000) minus the present value of the unguaranteed residual value ($80,000 x 0.74726): $220,000 – $59,780.80 = $160,219.20. The annual payment to be made by Horseshoe to Jason is $35,882.48 ($160,219.20/4.46511), The lease liability after the first payment on January 1, 20×5 is $124,336.72 ($160,219.20 – $35,882.48), The interest expense on December 31, 20×5 is $7,460.20 ($124,336.72 x 6%), Therefore, the amortization of the right-of-use asset on December 31, 20×5 is $28,422.28 ($35,882.48 – $7,460.20)