Accounting 202: Intermediate Accounting II Ch 5. Accounting for Operating & Capital Leases

Lease

someone makes a monthly payment for as long as they have the right to use the asset

Operating Lease

a lease that allows you to use an asset but doesn’t give you the benefits usually associated with ownership

Why might a company enter into an operating lease?

1. They want to own the asset at the end of its life

2. To hide the asset from creditors

3. They want permanent use of the asset

4. They only need to use the asset for a defined period of time

They only need to use the asset for a defined period of time

Which criteria is NOT one of the requirements to account for a lease as an operating lease?

1. lease cannot include a bargain purchase

2. ownership cannot transfer to lessee at the end of the lease

3. lease payments must be less than 50% of the fair value of the leased asset

4. lease term must be less than 75% of useful life

lease payments must be less than 50% of the fair value of the leased asset

Which transaction is LEAST LIKELY to be treated as an operating lease?

1. Leasing a free-standing retail store for a 20-year term with an option to renew for another 20 years

2. Leasing one floor of office space within a 5-story building

3. Leasing laptop equipment for your entire staff

4. Leasing space to temporarily store equipment for a lawn care company

Leasing a free-standing retail store for a 20-year term with an option to renew for another 20 years

Which of these transactions is most likely to receive operating lease accounting treatment?

1. Leases of cars for 2 years as part of a fleet of cars used by company executives.

2. Lease of laptop computers for a five-year term.

3. Lease of factory equipment that is customized to the business with no other use at the end of its lease term.

4. Lease of an entire office building for a 20-year term with a bargain option to purchase the building or renew the lease for another 20 years.

Leases of cars for 2 years as part of a fleet of cars used by company executives.

What entry is posted for a transaction accounted for as an operating lease?

1. Dr. Lease Obligation, Cr. Equipment

2. Dr. Cash Cr., Rental Expense

3. Dr. Rental Expense, Cr. Cash

4. Dr. Equipment Cr., Lease Obligation

Dr. Rental Expense, Cr. Cash

Capital Lease

a financing scheme

Present Value

since they delay the receipt of the money into the future, we somehow have to figure out what all those payments that you make in the future are worth today

Why would a business owner enter into a capital lease instead of an operating lease?

1. Because it's the cheapest way for them to finance purchase of the asset

2. Because they want to have full control of the asset

3. Because they don't know any better

4. Because they don't want to record the asset on their books; they just want to have use of the asset for a period of time

Because they want to have full control of the asset

Given what you now know about capital leases, which of the following would you expect to have a lot of leased assets that could potentially qualify as capital leases?

1. Doctors' offices

2. The airline industry

3. K-12 educational institutions

4. Restaurants

The airline industry

What distinguishes a capital lease from an operating lease?

1. The lessee has to return the asset in an operating lease

2. The lessee has use of the asset in a capital lease but not in an operating lease

3. Payments differ in a capital lease versus an operating lease

4. The lessee owns the asset in a capital lease

The lessee owns the asset in a capital lease

Which of the following terms in a lease WOULD NOT result in capital lease accounting treatment?

1. fair value of lease payments that is less than 90% of fair value

2. ownership transfer

3. bargain purchase option

4. lease term that exceeds 75% of fair value

fair value of lease payments that is less than 90% of fair value

You're handed a lease with the following lease terms:

1) 10-year lease term with a bargain option to renew for another 10 years. Useful life of the asset: 25 years.

2) Leased asset returns to the lessor at the end of the lease if the bargain option is not used.

3) Fair value of the lease payments is $200,000. Fair value of the leased assets is $225,000.

If you wanted to make sure that this lease would be treated as an operating lease, what changes would you recommend?

1. Eliminate the bargain option to renew the lease.

2. All answers are correct.

3. Decrease the lease payments so that the fair value is less than $190,000.

4. None; the lease terms are fine as they are.

Eliminate the bargain option to renew the lease.

Operating Lease

• the rights and responsibilities of ownership stay with the lessor (the one who owns the asset and leases it out)

• the lessee (the one who uses the asset) doesn’t record the value of the asset on their balance sheet

• the make periodic payments for use of the asset

Capital Lease

the lessee makes periodic payments, but they also get ownership of the asset

Each lease payment is composed of a portion that is _____ and a portion that is _____

1. depreciation, accumulated depreciation

2. principal, morals

3. principal, interest

4. lease payable, cash

principal, interest

_____ expense is recorded to reduce the leased asset's book value.

1. Accumulated

2. Depreciation

3. Discriminate

4. Depletion

Depreciation

In the first year of a capital lease, what is the interest portion of the payment if the principal is $50,000 and the expected rate of return is 12%?

1. $6000

2. $8000

3. $4000

4. $10,000

$6000

In a capital lease, if you did not want to show the leased asset on your books, which party would you want to be?

1. lessee

2. lessor

3. lease

4. bank

lessor

In a capital lease, the lessee _____ its accounting books.

1. waits until the end of the lease to put the asset on

2. takes the leased asset off

3. puts the leased asset on

4. records nothing on

puts the leased asset on

accrual accounting

expenses are recognized as they are accrued

Operating Leases

the equivalent of rental payments

In an operating lease, on the lease payment date, the balance sheet is _____.

1. decreased

2. increased, then decreased

3. unchanged

4. increased

unchanged

In an operating lease, on the first payment date, the income statement is _____.

1. increased

2. decreased

3. unchanged

4. first increased, then decreased

unchanged

In an operating lease, on the specified payment date, the cash flow statement shows a(n) _____.

1. decrease

2. no change

3. interest rate

4. increase

decrease

In an operating lease, the value of the leased equipment goes on the _____ balance sheet.

1. lessor's

2. lessee's

3. lessee's first then the lessor

4. lessor's first then the lessee

lessor's

Operating leases are the equivalent of _____ payments.

1. landlord

2. accural

3. fictitious

4. rental

rental