Leases

Medium Practice Test

Intermediate Accounting 2

Key Things To Know

j

Practice As You Learn

Self Test

b

Easy Practice Test

h

Medium Practice Test

i

Hard Practice Test

Medium Practice Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. FASB’s guidance that requires an asset and a liability to be reported for a finance lease is supported by the concept of

a. form over substance
b. conservatism
c. substance over form
d. consistency

Answer
C. The substance of a finance lease is a purchase of an asset using the lease to finance the purchase. The transfer of the asset is in-substance a purchase and sale, although the form is a lease agreement and title may not transfer.

2. Which type of lease results in profit on the asset for the lessor?

a. sales type
b. finance
c. operating
d. direct finance

Answer

A. The sales-type lease with sales profit results in gross profit for the lessor. The price of the asset the lessor finances under the lease is greater than the cost to the lessor. The result is profit on the sale (or in-substance sale) of the asset.

3. Which of the following type of lease allows the lessee to not report a liability on the balance sheet

a. sales-type with profit
b. sales-type without profit
c. finance
d. short-term

Answer
D. The lessee with a lease agreement for one year or less can elect to not report a liability on the balance sheet. The lessee will report a liability for payments promised under all other lease agreements.

4. Which of the following expenses will a lessee who has an operating lease report separately on the income statement?

a. depreciation expense
b. usage expense
c. lease expense
d. interest expense

Answer
C. The two expenses associated with an operating lease, interest and amortization, are combined and reported as lease expense. Usage expense is not an account that is used.

5. The amount of initial lease receivable a lessor records for a sales-type with sales profit is

a. not equal to the amount of lease payable the lessee records
b. equal to the present value of all lease payments
c. equal to total depreciation expense recorded over the life of the lease
d. equal to the total amount of all lease payments

Answer
B. The initial lease receivable is always equal to the present value of all lease payments. This is the cost that the lessee will pay to the lessor for the asset. The initial lease receivable does not include the interest that is included in the total lease payment. The lessor does not record depreciation expense when the lease is a sales-type lease. The lessee and the lessor record the same amount for the initial lease receivable and lease payable.

6. When the guaranteed residual value is greater than the fair market value of the asset at the end of the lease, the lessor records the asset at

a. fair market value
b. book value
c. residual value
d. original cost of the asset

Answer

A. The lessor must record the asset at fair market. The lessor records the difference in the residual value and fair value as a gain or a loss in the period the lessee returns the asset to the lessor.

7. When the lessee has a bargain purchase option, the life of the lease is equal to

a. the full term stated in the lease
b. the total years before the bargain purchase option price is determined
c. the total years before the bargain purchase option can be exercised
d. the life of the asset

Answer
C. The lease term is the length of time prior to the bargain purchase option exercise date. The lessor assumes the lessee will purchase the asset at the bargain price and the lease will end when the lessee purchases the asset.

8. The most common reason for accounting for a lease as an operating lease is

a. title transfers at the end of the lease
b. the lease term is less than most (75%) of the life of the asset
c. the present value of minimum lease payments is greater than 90%
d. there is no bargain purchase option

Answer
B. The most common reason a lease is an operating lease is a short lease term. The short lease term results in a lower number of payments that causes the PV of lease payments to be than substantially all (90%) of the assets fair value. Additionally, title does not transfer because the lessee pays a minimal amount of the value of the asset.

9. Which of the following is not true for the amortization schedule?

a. the amortization schedule always begins with the fair value of the asset
b. interest expense decreases in each subsequent period
c. the amount owed decreases in each subsequent period
d. the amortization schedule ends with nothing owed

Answer
A. The amortization schedule begins with the present value of total lease payments, which is not always the fair value of the asset depending on the terms of the lease. The amount owed and interest expense on the amount owed decrease as time passes. At the end of the lease the amount owed is zero.

10. A lessee records the gain on a sale-leaseback

a. over the life of the lease
b. at the time the asset is sold
c. when the first lease payment is exchanged between the lessee and the lessor
d. never, a gain is not allowed

Answer
B. A gain on a sale leaseback is recorded at the time the asset is sold because the sale leaseback meets the revenue recognition requirements. The lessee accounts for the sale-leaseback as a separate transaction.
11. JR Leasing is a direct financing lease company that will purchase an asset for another company and lease it to them. At the beginning of the current year, JR purchased manufacturing equipment and leased it to Inco Manufacturing for annual payments of $22,000, payable at the inception of the lease and the end of each year that follows for a total of 7 payments. The stated rate is 8% and Inco Manufacturing has the option to (and is reasonably expected to) purchase the equipment at the end of the 5th year for $15,000. The agreement contains no residual value for the equipment that is expected to have a useful life of 10 years.

A. Calculate the cost of the equipment to Inco Manufacturing.
B. Prepare the amortization schedule for the lease.
C. Prepare the journal entries at the inception of the lease for the lessee and the lessor
D. Prepare all journal entries at the end of the second year for the lessee and
the lessor.
E. Prepare the journal entries required for the transfer of the asset at the end of the
lease.

Answer

A. Calculate the cost of the equipment to Inco Manufacturing: 5p / 8%

Cost or FMV of asset 105,076
– Present value of RV or BPO (10,209)
= Payments cover 94,867
/ PV factor from annuity due table 4.31213
= Annual Payment 22,000

Use the formula, put in the payment and work up to get the cost

Use a period of 5 years because when the bargain purchase is available the lessee is reasonably expected to purchase the asset.

The PV of lease payments must be $105,076 for a $22,000 annual payment

B. Amortization Schedule:

Payment
Date		 Payments 10%
Interest		 Decrease Outstanding
    Balance
1/1/20X1 $105,076
1/1/20X1 $22,000 $22,000 $  83,076
12/31/X1 $22,000 $6,646 $15,354 $  67,722
12/31/X2 $22,000 $5,418 $16,582 $  51,140
12/31/X3 $22,000 $4,091 $17,909 $  33,231
12/31/X4 $22,000 $2,658 $19,342  $  13,890
12/31/X5 $15,000  $1,110 $13,890 $           0

C. Inception of the lease

Lessor Lessee
 
Lease Receivable    $105,076 Right of Use Asset   $105,076
            Asset                          $105,076             Lease Payable         $105,076
 
Cash                          $22,000 Lease Payable         $22,000
            Lease Receivable    $22,000             Cash                          $22,000

D. End of Year 2:

Lessor Lessee
 
Cash                          $22,000 Interest Expense      $  5,418
            Lease Receivable    $16,582 Lease Payable           $16,582
            Interest Revenue     $  5,418             Cash                          $22,000
 
Amortization Expense      $10,508

            Right to Use Asset         $10,508

 
             ($105,076 /10-yr life of asset)       

E. Exercise of Purchase Option

Cash                          $15,000 Interest Expense      $  1,110
            Lease Receivable    $13,890 Lease Payable          $13,890
            Interest Revenue     $  1,110             Cash                          $15,000
 
Asset                           $105,076
            Right to use asset       $105,076

12. JenMar, Inc. manufactures machines with that cost $125,000 and have an estimated useful life of 10 years. At the beginning of the current year, JenMar leases a machine to Nano, Inc. for a period of 5 years. The lease agreement requires payment at inception of the lease and on December 31st of each subsequent year. The annual finance rate is 12% and the sales price of the machine to Nano, Inc is $200,000. Title transfers to Nano, Inc. at the end of the lease.

A. Calculate the lease payment
B. Prepare the lease amortization schedule for the first two payments using the
effective interest method.
C. Record the journal entries for Jenmar and Nano at the inception of the lease.
D. Record all journal entries for Jenmar and Nano for the third year of the lease.
E. Prepare the journal entries required for the transfer of the asset at the end of the
lease for Jenmar and Nano.

Answer

A. Calculate the lease payment: 5p/12%

Cost or FMV of asset 200,000
– Present value of RV or BPO (           0)
= Payments cover 200,000
/ PV factor from annuity due table 4.03735 
= Annual Payment 49,537

B. Amortization Schedule:

Payment
Date		 Payments 12%
Interest		 Decrease Outstanding
    Balance
1/1/20X1 $200,000
1/1/20X1 $49,537 $49,537 $150,463
12/31/X1 $49,537 $18,056 $31,481 $118,982
12/31/X2 $49,537 $14,278 $35,259 $  83,722
12/31/X3 $49,537 $10,047 $39,490 $  44,232
12/31/X4 $49,537 $  5,305 $44,232 $           0

C. Inception of the lease

Lessor Lessee
 
Lease Receivable    $200,000 Right of Use Asset   $200,000
            Sales Revenue        $200,000             Lease Payable         $200,000
Cost of Goods Sold  $125,000
            Inventory                   $125,000
 
Cash                          $49,537 Lease Payable         $49,537
            Lease Receivable    $49,537             Cash                          $49,537

D. End of Year 3:

Lessor Lessee
 
Cash                          $49,537 Interest Expense      $10,047
            Lease Receivable    $39,490 Lease Payable           $39,490
            Interest Revenue    $10,047             Cash                          $49,537
 
Amortization Expense      $40,000

            Right to Use Asset            $40,000
            ($200,000 / 5-yr lease)      

E. End of the Lease

No entries are made to transfer the asset when the lease contains no residual value or bargain purchase option.

13. Crow, Inc. leases machines with an estimated useful life of 10 years. At the beginning of the current year, Crow leased a machine to Steel, Inc. for 7 years at a stated rate of 8%. The lease agreement requires payment at the inception of the lease and on December 31st of each year. The lease agreement contains an un-guaranteed residual value of $12,000. The lease payment is $50,000. Steel, Inc.’s incremental borrowing rate is 9%. The interest in the final period of the lease is $889.

A. Calculate the cost of the machine to Steel, Inc.
B. Prepare the lease amortization schedule for the first three payments.
C. Record the entries at the inception of the lease for the lessor and the lessee.
D. Record the entries for both the lessor and the lessee at the end of the second year.
E. Prepare the journal entries required for the transfer of the asset back to Crow, Inc.
at the end of the lease when fair market value is $10,000

Answer

A. Calculate the lease payment: 7p / 8%

Use the formula, start with the payment and work up to get the cost

Cost or FMV of asset 288,146    Lessor table
– Present value of RV or BPO (  7,002)   12,000 x .58349 7p/8%   
= Payments cover 281,144    Lessee table
/ PV factor from annuity table 5.62288    PV table annuity due 7p/8%
= Annual Payment 50,000

B. Amortization Schedule:

Payment
Date		 Payments 8%
Interest		 Decrease Outstanding
    Balance
1/1/20X1 $288,146
1/1/20X1 $50,000 $50,000 $238,146
12/31/X1 $50,000 $19,052 $30,948 $207,198
12/31/X2 $50,000 $16,576 $33,424 $173,773

C. Inception of the lease

Lessor Lessee
 
Lease Receivable    $288,146 Right of Use Asset         $288,146
              Sales Revenue        $288,146              Lease Payable            $288,146
Cash                         $50,000 Lease Payable         $50,000
              Lease Receivable      $50,000             Cash                          $50,000
 
        

D. End of  Year 2:

Lessor Lessee
 
Cash                          $50,000 Interest Expense        $16,576
              Lease Receivable        $33,424 Lease Payable             $33,424
              Interest Revenue        $16,576              Cash                             $50,000
 
Amortization Expense     $41,164
                     Right to Use Asset        $41,164
            ($288,146 / 7-year lease)  

D.  End of Lease

Lessor Lessee
Asset                        $12,000 No Entry
          Lease Receivable        $11,111 Right to Use Asset balance = 0
          Interest Revenue        $     889