IA3 Unit 5

Which of the following best describes current practice in accounting for leases?

All long-term leases are capitalized.

What single lease expense is recognized on the income statement?

An operating lease

Which of the following is an advantage of captive leasing companies over the other players in the leasing market?

They have the point-of-sale advantage in finding leasing customers.

What is a major reason why a company may become involved in leasing to other companies?

Tax incentives

In computing the present value of the lease payments, what rate should the lessee use?

use the implicit rate of the lessor, assuming that the implicit rate is known to the lessee

Which of the following statements is the correct amount for a lessee recording a right-of-use asset under a finance lease?

Present value of the lease payments

Which of the following is a correct statement of one of the lease classification tests?

The lease payments equal or exceed 90% of the fair value of the leased property at the start of the lease.

What is included in the present value of the lease receivable for a lessor under a sales-type lease?

Rental payments plus the present value of guaranteed and unguaranteed residual values

In computing amortization of a leased asset where there is no bargain purchase option, what should the lessee subtract?

No residual value and amortize over the term of the lease

A lessee had a ten-year finance lease requiring equal annual payments. What should the reduction of the lease liability in year 2 be equal to?

The current liability shown for the lease at the end of year 1

In order to be an operating lease, the lease must fail all five of the classification tests. Which of the following describes the lease term test?

If the lease term is 75% or more of the economic life, it is a finance lease

Hull Co. bought equipment and immediately leased it to Riggs Company on May 1, 2021. At that time, the collectibility of the lease payments was not probable. The lease expires on May 1, 2022. Riggs could have bought the equipment from Hull for $5,600,000 instead of leasing it. Hull’s accounting records showed a book value for the equipment on May 1, 2021, of $4,900,000. Hull’s depreciation on the equipment in 2021 was $630,000. During 2021, Riggs paid $1,260,000 in rentals to Hull for the 8-month period. Hull incurred maintenance and other related costs under the terms of the lease of $112,000 in 2021. After the lease with Riggs expires, Hull will lease the equipment to another company for two years.

What is Hull's income before income taxes related to his lease for the year ended December 31, 2021?

$518,000

In an operating lease, what does the lessee record?

lease expense

A sales-type lease has an unguaranteed residual value at the end of the lease term. At which amount would the lessor report sales revenue in the period of the inception of the lease?

The sales price less the present value of the residual value

How should the lease liability balance be disclosed on the balance sheet of the lessee?

Current portions in current liabilities and the remainder in noncurrent liabilities

Which of the following would be included in the Lease Receivable account on the lessor’s books?

• I. Guaranteed residual value

• II. Unguaranteed residual value

• III. Overhead costs

• IV. Rental payments

I, II, and IV

What is an advantage of leasing?

Leases offer protection against obsolescence.

For a lessee with a finance lease containing a bargain purchase option, what is the lease asset depreciated over?

The asset's remaining economic life

In a finance lease, what does the lessee record?

Amortization expense and interest expense

Metcalf Company leases a machine from Vollmer Corp. under an agreement that meets the criteria to be a finance lease for Metcalf. The six-year lease requires payment of $170,000 at the beginning of each year, including $25,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor’s implicit rate is 8% and is known by the lessee. The present value of an annuity due of $170,000 for six years at 8% is $848,761. The present value of an annuity due of $170,000 for six years at 10% is $814,435. The present value of an annuity due of $145,000 for six years at 8% is $723,943. The present value of an annuity due of $145,000 for six years at 10% is $694,664.

At which value should Metcalf record the leased asset?

$848,761

Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2021, it leased equipment with a cost of $480,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments of $175,820 at the end of each year. The equipment has an expected useful life of 5 years. Silver Point’s incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $780,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is Silver Point's book value of the leased asset at December 31, 2021?

$468,000

Company A leases a piece of machinery to Company B on January 1, Year 1. Information pertaining to the lease is as follows:

• The lease is non-cancellable with a term of three years.

• The machinery has a cost and fair value at the start of the lease of $40,000; an estimated economic life of five years; and a residual value at the end of the lease of $7,500 (unguaranteed).

• The present value of the lease payments at the inception of the lease is $32,500.

• The lease contains no renewal options, and the machinery reverts to Company A at the end of the lease.

• The present value of the residual value has been calculated as $6,478.

How much should Company B record as the right of use asset on January 1, Year 1?

$32,500

A company is leasing cars for four years at an agreed price of $500 per month, per car. The company provides the option to each lessee to lease each car for one additional year for an agreed upon price of $100 per month. The historical trend is that a lessee will take advantage of leasing the car for the one additional year due to this reduction in the monthly lease price. Each car has a useful life of six years. The company classifies the lease as a finance lease based on a specific test.

Which test did the company use for this purpose for classifying this lease based on the information provided?

Lease term

On January 1, Year 1, a corporation signed an agreement to lease a delivery truck for 36 months. The fair market value of the truck was $80,000 as of January 1, Year 1. The corporation estimates that the truck's fair market value will be $20,000 on December 31, Year 3. The corporation is reasonably certain it will exercise the lease option to purchase the delivery truck for $1,000 at the end of the lease.

How will the corporation report lease payments in its income statement?

Partially as amortization expense and partially as interest expense

Company A (lessee) has reached a lease agreement with Company B (lessor) to lease a new boom lift beginning January 1, Year 1. This is an operating lease with no renewal option and contains the following information:

• The lease is for three years, requiring annual payments at the beginning of the year of $10,213.

• The boom lift has a cost and fair value at the beginning of the lease of $40,000; an estimated economic life of five years; and a non-guaranteed residual value of $12,500.

• Present value of the residual value is $10,798.

• Company B depreciates assets like the boom lift using straight-line depreciation.

How should Company B record the lease payments received on January 1, Year 2?

Debit Cash for $10,213: Credit Unearned Lease Revenue for $10,213

A lessor incurs $10,000 of initial direct costs related to an operating lease.

How should the $10,000 cost be treated?

Defer the cost and allocate it over the term of the lease in proportion to the recognition of rental revenue.

Company A leased a delivery truck from Company B. The initial measurement of Company A's lease liability is $100,000. Company A paid $2,000 to its attorney for legal assistance with the lease agreement. Company B paid $5,000 to Company A as an incentive to lease the vehicle.

What is Company A's initial value of its right-of-use asset for the delivery truck?

$97,000

Company A leases computers from Company B with annual payments of $6,469. The leases are for two years, and the computers have an economic life of three years. At the end of the lease, the computers are expected to have a residual value of $5,000.

Company A has an option to purchase the computers for $2,000 at the end of the lease agreement, which it expects to do. The fair value of the lease is $15,000, and the present value of the lease is $12,689. The present value of the option to purchase the computers is $1,849.

How does Company A account for the amortization of the computers due to the bargain purchase option?

It will amortize $14,538 using the economic life of the computers.

Which two finance lease elements are a part of each lease payment?

A reduction of the lease liability and the recording of a financing cost (interest expense)

Company A agrees to lease racks to Company B for five years. The expected economic life of the racks are five years. At the end of the lease, Company B has the right to purchase the racks for $5,000, but the company is not certain it will exercise the right.

Which test must the lease pass to be classified as a finance lease?

Lease term

Company A (lessee) has reached an operating lease agreement with Company B (lessor) to lease a new boom lift beginning January 1, Year 1. The lease agreement contains no renewal options and contains the following information:

• The lease is for three years, requiring annual payments at the beginning of the year of $10,213.

• The boom lift has a cost and fair value at the beginning of the lease of $40,000; an estimated economic life of five years; and a non-guaranteed residual value of $12,500.

• Present value of the residual value is $10,798.

• Company B depreciates assets like the boom lift using straight-line depreciation.

What is the depreciation expense for Year 2 that the lessor will record?

$8,000

Company A has agreed to lease a full body scanner to Company B. The lease has the following information:

• The lease is for three years, requiring annual payments at the beginning of the year of $6,352.

• At the end of the lease, Company B may purchase the scanner for $5,000, and the company feels certain it will exercise this right.

• The scanner has a fair value at the beginning of the lease of $25,000; an estimated economic life of five years; and a guaranteed residual value of $7,800.

• Present value of the scanner is $18,333.

Which test does the lease pass in order to be classified as a finance lease?

Purchase option

A start-up company is trying to decide if it should purchase or lease cellular phones for its 2,500 new employees.

Which decision should the company make?

Lease, because leasing can pass the risk of residual value to the lessor

Company A leases cars from Company B for their salespeople. The leases are for three years. Company A paid a commission to a third party for helping to negotiate the leases from Company B.

How should Company A account for this commission?

Include the commission in the amount for the right-of-use asset but not in the lease liability

Company A leases computers from Company B with annual payments of $6,469. The leases are for two years, and the computers have an economic life of three years. At the end of the lease, the computers are expected to have a residual value of $5,000.

Company A has an option to purchase the computers for $2,000 at the end of the lease agreement, which it expects to do. The fair value of the lease is $15,000, and the present value of the lease is $12,689. The present value of the option to purchase the computers is $1,849.

How should Company A account for the amortization of the computers due to the bargain purchase option?

It should amortize $14,538 using the economic life of the computers.

Which two finance lease elements are a part of each lease payment?

A reduction of the lease liability and recording the financing cost (interest expense)

Company A agrees to lease racks to Company B for five years. The expected economic life of the racks are five years. At the end of the lease, Company B has the right to purchase the racks for $5,000, but the company is not certain it will exercise the right.

Which test does the lease pass to be classified as a finance lease?

Lease term

A lessor leases a piece of equipment to a lessee, under lease terms that qualify as an operating lease. The present value of required rental payments is $280,000; and the present value of the estimated residual value, which is unguaranteed, is $30,000. The lessor incurred total costs of $160,000 to build the leased asset.

Which amount of lease receivable, if any, should the lessor record?

$0

A company wishes to avoid classifying a lease as a finance lease.

Which criterion will prevent the company from reaching this goal?

There is a bargain price option.

A company is looking for additional guidance on which equipment to lease. The company is using a lessor that has knowledge about the parent's product that can be passed on to the company.

Which lessor is being used by the lessee?

Captive leasing companies

Company A agrees to lease a robotic welding unit from Company B on January 1, Year 1. The following conditions apply to the lease:

• The term of the lease is five years, is non-cancellable, and requires payments of $101,350 at the beginning of each year.

• The robotic welding unit will have an estimated fair value of $50,000 at the end of the lease; an estimated useful life of five years; and $45,000 guaranteed residual value.

• There are no renewal options, so the unit will revert to Company B at the termination of the lease.

• Company A can borrow at a 5% interest rate.

• Company A uses straight-line depreciation on its assets.

• Company B set its annual rate of return at 4%, and Company A is aware of this rate.

• Present values are as follows:

  • Present value of lease payments at 5%: $469,240

  • Present value of lease payments at 4%: $460,737

  • Present value of residual at 4%: $38,457

  • Present value of residual at 5%: $37,021

Which amount should be used to record the lease on the lessee’s books on January 1, Year 1?

$460,737