Leases

Self 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

Self Test

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

1. The party that has the right to use the leased asset is called

a. the lessee
b. the lessor

Answer
A. The lessee has the right to use the leased asset in exchange for periodic payments. The lessor provides the asset in return for periodic cash payments. Title may or may not transfer at the end of the lease depending on the terms of the lease.

2. An operating lease is

a. one where the lease term is substantially all of the asset’s useful life
b. one where the lesser pays substantially less than the assets fair value
c. one where payments are always made monthly
d. one that meets two or more of the criteria for a finance lease.

Answer
B. An operating lease is not in substance a financed purchase, as evidenced by leasing the asset for less than most of the asset’s useful life or paying less than substantially all of the fair value of the asset. The payment schedule is negotiated and does not have to be monthly. Meeting any one of the five criteria makes it a finance (lessee) or sales-type (lessor) lease and indicates in-substance a financed purchase.

3. Two accounts a lessee uses to record an operating lease are

a. lease payable and amortization expense
b. interest expense and interest revenue
c. interest expense and amortization expense
d. depreciation expense and interest expense

Answer
C. For an operating lease, the lessee records a lease payable, a right to use asset, interest expense, and amortization expense. The lessee reports the two accounts as total lease expense on the income statement. Lease expense will equal the lease payment.

4. When accounting for an operating lease, the lessor will record

a. lease receivable and interest revenue
b. lease revenue and depreciation expense
c. lease expense and depreciation expense
d. lease liability and interest expense

Answer
B. The lessor maintains the asset on their balance sheet and records depreciation expense on the asset along with lease revenue for the payment amount. The lessor does not record a lease receivable, interest revenue, a lease liability, or interest expense for an operating lease.

5. One of the five criteria that must be met for the lessee to record a financing lease is

a. the cost of the asset is greater than 90% of total lease payments
b. the lessee uses the asset for approximately half of the asset’s useful life
c. the present value of minimum lease payments is substantially all of the fair value of the asset
d. both a. and b.

Answer
C. When present value of minimum lease payments is greater than 90% of the cost of the asset it is assumed that the lessee is effectively purchasing the asset. Other criteria are: title passes, the asset is leased for most of the asset’s useful life (75%+), or there is a bargain purchase option.

6. A lessee can choose not to report a right to use asset and a related liability when

a. the lessee has the right to use the asset for more than one year
b. the PV of lease payments is less than 50% of the fair value of the asset
c. the lessee uses the asset for less than 25% of the asset’s useful life
d. the lessee has the right to use the asset for one year or less

Answer
D. A lessee can choose not to report a right to use asset and a related liability when the lease term is one year or less (and the lessee has no option to and is not reasonably expected to extend the lease).

7. In a sales-type lease with sales profit, the lessor generally earns income from

a. selling the asset for greater than cost
b. interest earned through financing the sale
c. appreciation of the leased asset
d. both a. and b.

Answer
D. In a sales-type lease with sales profit, the lessor sells the asset at a price greater than cost and earns profit on the sale. Additionally, the lessor finances the purchase and earns interest revenue on the loan. The leased asset generally depreciates while the lessee has the right to use.

8. In a sales type lease without sales profit, the lessor generally earns income from

a. selling the asset for greater than cost
b. interest earned through financing
c. appreciation of the leased asset
d. both a. and b.

Answer
B. In a sales-type lease without sales profit, the lessor gives the lessee the right to use the asset at an amount equal to the cost of the asset and earns no profit on the asset. The lessor earns interest revenue from financing the right to use. The leased asset generally depreciates while the lessee has the right to use.

9. The lessee’s incremental borrowing rate is the

a. rate the lessee can obtain financing
b. rate stated in the lease agreement
c. negotiated rate between the lessor and the lessee
d. current market rate for long term treasury bonds

Answer
A. A lessee’s incremental borrowing rate is the rate financing can be obtained from a bank or financing institution.

10. Executory costs consist of

a. maintenance and property taxes
b. insurance, maintenance, and property taxes
c. interest, maintenance, and property taxes
d. property taxes and cleaning

Answer
B. Executory costs consist of insurance, maintenance, and property taxes related to the leased asset. Executory costs are often paid by the lessee and added to the lease payment.

11. Executory costs are

a. included in the amount owed when computing interest
b. not included in the amount owed when computing interest
c. never paid by the lessee
d. not typically included in the periodic payment to the lessor

Answer
B. Executory costs are separate from the cost of leasing the asset. They are not included in the amount used to determine interest for each period. It is common that the periodic payment includes executory costs; however, no interest is charged because it is not part of the financed amount.

12. A bargain purchase option

a. requires the lessee to purchase the asset at the end of the lease
b. gives the lessee the option to purchase the asset at a price the lessee would reasonably exercise
c. is always a price of $1
d. gives the lessor the option to keep the asset at the end of the lease

Answer
B. A bargain purchase option gives the lessee the option to purchase the asset at a price the lessee would not reasonably turn down. The lease is assumed to end when the bargain purchase option becomes effective.

13. When calculating a lease payment

a. add the present value of the residual value
b. add the present value of the residual value or bargain purchase option
c. multiply by the present value factor of the annuity
d. subtract the present value of the residual value or bargain purchase option

Answer
D. The present value of residual value (both guaranteed and unguaranteed) and the bargain purchase option are subtracted from cost when determining the lease payment.
This amount will be settled at the end of the lease and is not part of the periodic payment.

14. The amortization schedule will end with an amount

a. equal to the guaranteed residual value for the lessee
b. equal to the un-guaranteed residual value for the lessee
c. the fair market value of the asset at the end of the lease
d. of zero

Answer
D. The amortization schedule ends with the amount of zero. The total cost of the asset plus all interest is paid to the lessor as the lessee makes periodic payments.

15. Who records depreciation expense when accounting for a lease where the lessee in substance is not purchasing the asset?

a. lessee
b. lessor
c. either lessee or lessor depending on the terms of the lease
d. depreciation expense is not recorded for a capital lease

Answer
B. In an operating lease (no financed purchase in-substance), the lessor records depreciation related to the use of the asset. The lessor continues to report the physical asset on their balance sheet. The lessee records amortization expense on the right to use asset that is not owned, similar to a leasehold improvement.