F6 m2 questions leases

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Henderson State University *

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Jan 9, 2024

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At the beginning of Year 2, Kennedy enters into a four-year operating lease with payments due at the end of the year beginning on December 31, Year 2. The rate implicit in the lease is 4.50 percent and Kennedy will owe annual payments of $5,200. The present value factor of an ordinary annuity for four years at 4.50 percent is equal to 3.5875. The carrying value of the lease liability at the end of Year 2 will be closest to: A, $9,740. B. $13455. C. $14,205. Choice "C" is correct. As shown in the amortization table below, the carrying value of the lease liability at the end of Year 2 will be approximately $14,295 The initial carrying value of the lease liability is the present value of the payments: $5,200 x 3.5875 = $18,655. Lease Expense Interest Carrying Value Date (Straight-line) (4.50% on Liability) Amortization of Lease Liability $ 18,655 12/31/Year 2 $ 5,200 $ 839 $4,361 14,294 12/31/Year 3 5,200 643 4,557 9,738 12/31/Year 4 5,200 438 4,762 4976 12/31/Year 5 5,200 224 4,976 (0)

Wall Co. leased office premises to Fox Inc. for a five-year term beginning January 2, Year 1. Under the terms of the operating lease, rent for the first year is $8,000 and rent for Years 2 through 5 is $12,500 per annum. However, as an inducement to enter the lease, Wall granted Fox the first six months of the lease rent-free. In its December 31, Year 1, income statement, what amount should Wall report as rental income? A $12,000 B. $11,600 C. $10,800 Choice "C" is correct. Rental income is recorded when it is earned (accrual basis), not when the cash is received. Therefore the total rental income should be recognized ratably over the five years. Rent in Year 1 (1/2 of $8,000) $ 4,000 Rent in Years 2-5 ($12,500 x 4) 50,000 Total rent 54,000 Year 1 rent (1/5 x $54,000) $10,800 At the beginning of the year, a lessee signs a five-year lease that contains a written purchase option, which the lessee is reasonably certain to exercise. In preparing the annual cash flow statement after year-end, the lessee's cash flow from operations will be: A. Positively impacted by the portion of the lease payments that represents interest. B. Negatively impacted by variable lease payments not included in the lease liability.

Choice "B" is correct. Because this lease contains a written purchase option that the lessee is reasonably certain to exercise, it will qualify as a finance lease (it meets the "W" criteria in "OWNES"). Variable lease payments not included in the lease liability are treated as cash outflows from operations and will therefore have a negative impact on bottom-line cash flow from operations. Choice "A" is incorrect. The interest portion of the lease payment will serve to reduce cash flow from operations, as itis a "CFO" outflow. Choice "C" is incorrect. The portion of the lease payment that represents principal is a cash flow from financing outflow. Choice "D" is incorrect. Short-term lease payments not included in the lease liability are treated as cash outflows from operations and will therefore have a negative impact on bottom-line cash flow from operations. On April 1, year 1, Hall Fitness Center leased its gym to Dunn Fitness Center under a four-year operating lease. Hall normally charges $6,000 per month to lease its gym, but as an incentive, Hall gave Dunn half off the first year's lease costs, and one quarter off the second year's lease costs. Dunn's lease payments were as follows: Year1 12 x $3,000 = $36,000 Year2 12 x $4,500 = $54,000 Year3 12 x $6,000 = $72,000 Year4 12 x $6,000 = $72,000 Dunn's lease payments were due on the first day of the month, beginning on April 1, Year 1. What amount should Dunn report as lease expense in its monthly income statement for April, Year 3? A. $3,000 B. $4,500 - C. $4875 D. $6,000

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Explanation Choice "C" is correct. Lease expense must be reported on a straight-line basis. When lease rates fluctuate and when reduced costs are given, the average lease rate must be computed. In this case, total lease expense over the life of the lease is $234,000 ($36,000 + $54,000 + $72,000 + $72,000) and the average lease expense is $58,500 per year ($234,000 / 4 years). $58,500 divided by 12 months equals $4,875 per month. A company has an operating lease for its office space. The lease term is 120 months and requires monthly lease payments of $15,000. As an incentive for the company to enter into the lease, the lessor granted the first eight months at no cost. What amount of monthly lease expense should be recognized over the life of the lease? A. $14,000 Choice "A" is correct. The lessor is granting 8 months free, so the total lease expense that will be recorded over the lease period is $1,680,000 (112 months x $15,000 per month). This expense must be equally allocated over the lease period of 120 months according to the revenue recognition and expense recognition principles (recognize expenses in the period in that they are incurred). Therefore, $14,000 of lease expense will be recorded every month ($1,680,000/120 months). 120 months @ $15,000 $1,800,000 8 months free (120,000) Total cost for 120 months $1,680,000 Total months leased +120 Monthly lease expense ~ $ 14,000

On January 1, Year 1, Glen Co. leased a building to Dix Corp. for a ten-year term at an annual rental of $50,000. At inception of the lease, Glen received $200,000 covering the first two years' rent of $100,000 and a security deposit of $100,000. This deposit will not be returned to Dix upon expiration of the lease but will be applied to payment of rent for the last two years of the lease. What portion of the $200,000 should be shown as a current and long-term liability, respectively, in Glen's December 31, Year 1 balance sheet? Current Liability Long-Term Liability A. $0 $200,000 B. $50,000 $100,000 Choice "B" is correct. $50,000 current liability; $100,000 long-term liability. Cash received in advance of earning the revenue is recorded as unearned revenue. The classification of the liability on the balance sheet between short-term and long-term depends on when the revenue will be eamed. Of the $200,000 received in advance and recorded to unearned revenue (Dr. cash $200,000 and Cr. uneamed revenue $200,000), $50,000 will be earned during Year 1 and $50,000 will be eamed during Year 2. The remaining $100,000 security deposit will be applied to rent at the end of the lease term and will not be earned until Years 9 and 10. At the end of Year 1, $50,000 of revenue has been earned (Dr. unearned revenue $50,000, Cr. revenue $50,000), leaving a remaining unearned revenue balance of $150,000. $50,000 will be earned in Year 2 and is therefore reflected as a current liat , because the obligation will be satisfied within a year from the balance sheet date. The remaining $100,000 is reflected as a long-term liability because it will be eared beyond one year from the balance sheet date. On June 1 of the current year, a company entered into a real estate lease agreement for a new building. The lease is an operating lease and is fully executed on that day. According to the terms of the lease, payments of $28,900 per month are scheduled to begin on October 1 of the current year and to continue each month thereafter for 56 months. The lease term spans five years. The company has a calendar year end. What amount is the company's lease expense for the current calendar year? A. $86,700 B. $161838 C. $188,813

Choice "C" is correct. If free or reduced rent is part of the lease package, the lessee must take the total lease expense to be paid for the entire term of the lease and divide it evenly over each period. Amount to be paid per month $ 28,900 Number of payments x 56 Total lease costs to be paid 1,618,400 Months in lease =60 Monthly lease expense 26,973 Months in current year x7 Lease expense for current year $ 188,813 On December 1 of the current year, Clark Co. leased office space for five years at a monthly rental of $60,000. On the same date, Clark paid the lessor the following amounts First month's rent $60,000 Last month's rent 60,000 Security deposit (refundable at lease expiration) 80,000 Installation of new walls and offices 360,000 Assuming that the lease is treated as an operating lease, what should be Clark's current year expense relating to utilization of the office space?

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. $60,000 A © B. $66,000 C. $120,000 D . $140,000 Explanation December (first month rent) $60,000 Add: Amortization of improvements (walls and offices) cost $360,000 + 60 months 6,000 Total current year expense $66,000 Choice " correct. $66,000 expense relating to office space. During January Year 1, Yana Co. incurred landscaping costs of $120,000 to improve leased property. The estimated useful life of the landscaping is fifteen years. The remaining term of the lease is eight years, with an option to renew for an additional four years. However, Yana has not reached a decision with regard to the renewal option. In Yana's December 31, Year 1, balance sheet, what should be the net carrying amount of landscaping costs? A. S0 © B. $105,000 C. $110,000 D. $112,000

Choice "B" is correct. $105,000. Rule: Amortization of leasehold improvements should be over the life of the improvements or the remaining life of the lease, whichever is shorter. Since there is uncertainty as to whether the lease will be renewed, the renewal option is not a factor. Leassholdimprovement _ $120000 RemaminglLifeofLease ~ 8vears - o100/ Year Leasehold improvements 1/1/Year 1 $120,000 Less Year 1 amortization (15,000) Leasehold improvements 12/31/Year 1 $105,000 Star Co. leases a building for its product showroom. The 10-year nonrenewable lease will expire on December 31, Year 10. In January Year 5, Star redecorated its showroom and made leasehold improvements of $48,000. The estimated useful life of the improvements is 8 years. Star uses the straight-line method of amortization. What amount of leasehold improvements, net of amortization, should Star report in its June 30, Year 5, balance sheet? A, $45600 B. $45,000 C. $44,000 D. $43,200

Explanation Choice "C" is correct. Leasehold improvements should be amortized over the lesser of the remaining life of the lease (6 years), the life of the improvement (8 years). $48,000 + 6 = $8,000 amortization for a year or $4,000 for January Year 5 through June 30, Year 5. $48,000 - $4,000 = $44,000. Oak Co. leased equipment for its entire nine-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next eight years. The present value on December 31, Year 1, of the nine lease payments over the lease term, using the rate implicit in the lease which Oak knows to be 10%, was $316,500. The December 31, Year 1, present value of the lease payments using Oak's incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as a lease liability in its December 31, Year 2, balance sheet? A. $350,000 © B. $243,150 Choice "B" is correct. The initial amount capitalized is the present value using the lessor's rate if known (10%). The following table shows the liability on 12/31/Year 2 Deciine in Date Payment Interest Liability Liability 12/31/Year 1 $316,500 12/31/Year 1 50,000 - 50,000 266,500 12/31/Year 2 50,000 26,650 23,350 $243,150

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On January 1, Year 1, Day Corp. entered into a 10-year lease agreement with Ward, Inc. for industrial equipment. Annual lease payments of $10,000 are payable at the end of each year. Day knows that the lessor expects a 10% return on the lease. Day has a 12% incremental borrowing rate. The equipment is expected to have an estimated useful life of 10 years. In addition, a third party has guaranteed to pay Ward a residual value of $5,000 at the end of the lease. The present value of an ordinary annuity of $1 at: * 12% for 10 years is 5.6502 * 10% for 10 years is 6.1446 The present value of $1 at: * 12% for 10 years is 0.3220 * 10% for 10 years is 0.3855 In Day's October 31, Year 1 balance sheet, the principal amount of the lease obligation was: A. $63374 © B. $61446 C. $58,112 D. $56,502

Explanation Choice "B" is correct. $61,446 principal amount of lease obligation in 10/31/Year 1 balance sheet. Rule: Lessee should use the rate implicit in the lease (if known by the lessee) to discount cash flows. Annual lease payments. $ 10,000 Present value of ordinary annuity x 6.1446 Lease obligation at 10/31/Year 1 $ 61,446 Note that the residual value of $5,000 is not included in the calculation of the lease obligation because it will be paid by a third party and not by Day Corp. A lessee had a 10-year finance lease requiring equal annual payments. The reduction of the lease liability in Year 2 should equal: © A. The current liability shown for the lease at the end of Year 1 B. The current liability shown for the lease at the end of Year 2. C. The reduction of the lease obligation in Year 1 D. One-tenth of the original lease liability. Explanation is correct. The reduction of the lease liability in Year 2 should equal the current liability shown for the lease at the end of Year 1. Rule: Finance leases should be recorded as both an asset and liability at the present value of the minimum lease payments. The asset is depreciated. The liability is amortized using the interest method. Each payment is allocated between principal and interest. The liability is reduced by the amount of principal reduction. The lease liability should be segregated between current (due within one year) and non-current (due beyond one year). Accordingly, the reduction in lease liability each year is equal to the current liability at the end of the previous year.

Alease is classified as a finance lease because it contains a written purchase option that the lessee is reasonably certain to exercise. Over what period of time should the lessee amortize the leased property? A. The term of the lease. © B. The economic life of the asset. C. The lease term or the economic life of the asset, whichever is shorter. D. The economic life of the asset, not to exceed 40 years. Explanation Choice "B" is correct. With a finance lease, the lessee should amortize the leased property over the economic life of the asset when there is a written purchase option or when the lessee takes ownership of the asset at the end of the lease term. Choice "A" is incorrect. The term of the lease is not the appropriate period over which to amortize the leased asset in this case. It is appropriate when the 75 percent or 90 percent criteria are met Choice "C" is incorrect. When the determination is made that a lease is a finance lease, the leased asset is to be amortized over its economic life or the asset life based on the capitalization criterion met. Choice "D" is incorrect. There is not a provision for a maximum of 40 years. Jay's lease payments are made at the end of each period. Jay's liability for a finance lease would be reduced periodically by the: A. Minimum lease payment less the portion of the minimum lease payment allocable to interest B. Minimum lease payment plus the amortization of the related asset. C. Minimum lease payment less the amortization of the related asset. D. Minimum lease payment.

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Explanation Choice "A" is correct. Minimum lease payment less the portion of the minimum lease payment allocated to interest represents the liability for a finance lease. Rule: For a finance lease, the minimum lease payment is allocated between principal and interest using the interest rate inherent in the lease. The portion allocated to principal reduces the remaining lease liability. The process is similar to a home mortgage. A six-year finance lease entered into on December 31, Year 1, specified equal minimum annual lease payments due on December 31 of each year. The first minimum annual lease payment, paid on December 31, Year 1, consists of which of the following? Interest expense Lease liability A. Yes Yes B. Yes No (o No Yes Explanation Choice "C" is correct. The debt was incurred on December 31, Year 1. The initial payment was made on December 31, Year 1. No interest expense is recognized since no time has passed between when the debt was incurred and the payment was made. Thus, the full amount of the payment reduces the lease liability. Choice "A" is incorrect. When payment is made on the same day as a debt is incurred, no interest expense is recognized since no time has passed since the debt was incurred. Choice "B" is incorrect. Since no interest has accrued and the full payment reduces the liability. Choice "D" is incorrect. Since no interest has accrued and the full payment reduces the liability.

A company leases a machine from Leasing Inc. on January 1, Year 1. The lease terms include a $100,000 annual payment beginning January 1, Year 1. The machine's fair value is $500,000 and an additional $20,000 in residual value is expected to be owed at the end of the lease term. The useful life of the machine is six years, and the lease term is five years. The implicit rate of interest is 6% and is known by the company. The following present value factors are provided: Five Years Six Years Present value of $1 at 6% 0.7473 0.7050 Present value of an annuity due at 6% 4.4651 52124 Present value of an ordinary annuity at 6% 42124 49173 What is the value of the machine in the company’s balance sheet at lease inception? A. $446510 © B. $461,456 C. $520,000 D. $535340 Choice “B” is correct. The lessee will record the lease as both an asset and a liability at the present value of minimum lease payments. The lease cost has two components: « Required payments: $100,000 x 4.4651 (the factor for an annuity due for five years at 6%) = $446,510. + Expected residual: $20,000 x 0.7473 (the present value of $1 at 6%) = $14,946. The two components combine for a total cost of $461,456 ($446,510 + $14,946)

Robbins Inc. leased a machine from Ready Leasing Co. The lease qualifies as a finance lease and requires 10 annual payments of $10,000 beginning immediately. The lease specifies an interest rate of 12% and a purchase option of $10,000 at the end of the tenth year, even though the machine's estimated value on that date is $20,000. Robbins' incremental borrowing rate is 14%. The present value of an annuity due of 1 at: 12% for 10 years is 6.328 and 14% for 10 years is 5.946. The present value of 1 at: 12% for 10 years is 0.322 and 14% for 10 years is 0.270. What amount should Robbins record as lease liability at the beginning of the lease term? A, $62,160 B. $64,860 C. $66,500 Explanation Choice "C" is correct. The lessee should record the finance lease at the present value of minimum lease payments. The interest rate to be applied is 12%. The lease payments begin immediately (annuity due basis). The purchase option must also be capitalized. The amount capitalized is: Annual payments, $10,000 x 6.328 $63,280 Written purchase option, $10,000 x 0.322 3,220 $66,500

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On December 31, Year 1, Day Co. leased a new machine from Parr with the following pertinent information: Lease term 6 years Annual rental payable at beginning of each year $50,000 Useful life of machine 8 years Day's incremental borrowing rate 15% Implicit interest rate in lease (known by Day) 12% Present value of an annuity of 1 in advance for 6 periods at 12% 461 Present value of an annuity of 1 in advance for 6 periods at 15% 435 The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $375,500. At the beginning of the lease term, Day should record a lease liability of: A. $375,500 B. $230,500 C. $217,500 D. $0

Choice "B" is correct. $230,500 lease liability at 12-31-Y1. Rule: A lease is a finance lease if its term represents the major part of the economic life of the asset, with 75% serving as a reasonable quantitative threshold. The rate to use to calculate present value is the lease's "implicit rate” if known by the lessee. Lease term 6yr =75% and is a capital lease Life of machine 8 yr Lease payment x PV factor at 12% PV of lease $50,000 x 461 $230,500 On January 1 of the current year, Tree Co. enters into a five-year lease agreement for production equipment. The lease requires Tree to pay $12,500 per year in lease payments. At the end of the five-year lease term, Tree can purchase the equipment for $30,000. The fair value of the equipment is $75,000. The estimated useful life of the equipment is 10 years. The present value of the lease payments is $50,000. The present value of the purchase option is $20,000. Tree's controller believes the purchase option price is sufficiently below the expected fair value of the equipment at the date the option becomes exercisable to reasonably assure its exercise. Tree would normally depreciate equipment of this type using the straight-line method. What amount is the carrying value of the asset related o this lease at December 31, of the current year? A. $40,000 B. $45,000 C. $56,000 D. $63,000

Choice "D" is correct. The lease qualifies for finance lease treatment as two of the four criteria are met for lease capitalization. First, a written purchase option that the lessee is reasonably certain to exercise is associated with the lease. Second, the present value of the minimum lease payments (the minimum rental payments and the purchase option) is greater than 90 percent of the fair value of the equipment [(50,000 + 20,000) > (90% x 75,000)]. The equipment will be recorded at a cost of $70,000 (the present value of minimum lease payments and bargain purchase option). As this lease contains a bargain purchase option, regarding the depreciation, the useful life of the asset rather than the lease period will be used to calculate depreciation. The $70,000 equipment cost less depreciation expense for one year of $7,000 (70,000/10- year useful life) results in a book value of $63,000 at the end of the current year. Quattro Corporation signed a lease from Cinco Leasing Company on July 1, Year 1, for equipment having a five-year useful life. The lease does not include any option to purchase the equipment at the end of the four-year lease term, nor does it include a provision for ownership transfer. Five equal payments of $10,000 per year are required by the terms of the lease, with the first payment due upon signing. Quattro's incremental borrowing rate is 8 percent, but its implicit interest rate is unknown. Present value of an annuity at 8% for 5 years = 3.993 Present value of an annuity at 8% for 4 years = 3.312 On its December 31, Year 1, financial statements, Quattro would display the following amounts in the indicated accounts under U.S. GAAP: Accumulated Lease Equipment Depreciation Payable A. $0 $0 $0 - B. $43,120 $5,390 $33,120 C. $43,120 $4,312 $33,120 D. $49,930 $6,241 $39,930

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B is the correct answer Choice "B" is correct. Quattro's lease qualifies for treatment as a finance lease since its term exceeds 75 percent of the useful life of the asset (4/5 or 80 percent). A liability (lease payable) will be recorded in the amount of the present value of the minimum lease payments and an asset will be recorded for the same amount. Because the lease does not meet the ownership transfer or written purchase option criteria, the asset will be depreciated over the term of the lease, not the life of the asset. Down payment due at signing $10,000 Annual lease payments $10,000 Present value of an annuity (8% x 4 years) 3.312 Lease liability 33,120 Present value of minimum lease payments (asset) 43,120 Depreciation period 4 years Annual depreciation expense $10,780 Six months depreciation $5,390

Steam Co. acquired equipment under a finance lease for six years. Minimum lease payments were $60,000 payable annually at year-end. The interest rate was 5% with an annuity factor for six years of 5.0757. The present value of the payments was equal to the fair market value of the equipment. What amount should Steam report as interest expense at the end of the first year of the lease? A $0 B. $3,000 C. $15227 Explanation Choice "C" is correct. The finance lease will be recorded by debiting ROU asset and crediting lease liability for $304,542 ($60,000 minimum lease payment x 5.0757 annuity factor). The interest expense in the first year will be calculated by multiplying the 5% interest rate times the lease liability: $304,542 x 5% = $15,227 Choice "A" is incorrect. Interest expense must be reported each period on the lease liability. Choice "B" is incorrect. Interest expense is calculated as the lease liability times the interest rate, not the annual payment times the interest rate. Choice "D" is incorrect. The lease liability is calculated as the minimum lease payment times the annuity factor, not the minimum lease payment times the number of years.

On December 31, Year 1, Neal Inc. leased machinery with a fair value of $105,000 from Frey Rentals Co. The agreement is a six- year noncancelable lease requiring annual payments of $20,000 beginning December 31, Year 1. The lease is appropriately accounted for by Neal as a finance lease. Neal's incremental borrowing rate is 11%. Neal knows the interest rate implicit in the lease payments is 10%. * The present value of an annuity due of 1 for 6 years at 10% is 4.7908 « The present value of an annuity due of 1 for 6 years at 11% is 4.6959 In its December 31, Year 1 balance sheet, Neal should report a lease liability of: A. $75816 Choice "A" is correct. $75,816. Rule: The present value rate used to value a finance lease is the lease's "implicit rate,” if known by the lessee. Annual lease payments $20,000 PV of annuity due of 1 for 6 years at 10% x 4.7908 Lease liability before 12/31/Year 1 payment 95,816 Less 12/31/Year 1 payment (20,000) Lease liability in 12/31/Year 1 balance sheet $75,816

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On January 1, Year 1, Babson, Inc. leased two automobiles for executive use. The lease requires Babson to make five annual payments of $13,000 beginning January 1, Year 1. At the end of the lease term, December 31, Year 5, Babson guarantees the residual value of the automobiles will total $10,000. The lease qualifies as a finance lease. The interest rate implicit in the lease is 9%. Present value factors for the 9% rate implicit in the lease are as follows: For an annuity due with 5 payments 4240 For an ordinary annuity with 5 payments 3.890 Present value of $1 for 5 periods 0.650 Babson's recorded lease liability immediately after the first required payment should be: Babson's recorded lease liability immediately after the first required payment should be: A. $48620 B. $44,070 C. $35620 D. $31,070

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Choice "A" is correct. $48,620 lease liability after the first required payment. Annual payments $13,000 PV of annuity due (at beginning of year) x4.240 PV of annual payments before first required payment 55,120 Less first payment (January 1, Year 1) (13,000) PV of annual payments after first required payment 42,120 Add PV of guaranteed residual value (PV of $ for 5 periods 0.650 x $10,000) 6,500 Lease liabilitv after first reauired pavment $48.620 On January 1, Year 1, Blaugh Co. signed a long-term lease for an office building. The terms of the lease required Blaugh to pay $10,000 annually, beginning December 30, Year 1, and continuing each year for 30 years. The lease qualifies as a finance lease. On January 1, Year 1, the present value of the lease payments is $112,500 at the 8 percent interest rate implicit in the lease. In Blaugh's December 31, Year 1, balance sheet, the lease liability should be: A, $102,500 B. $111,500

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Explanation Choice "B" is correct. $111,500 lease liability at 12/31/Year 1. Present value of lease liability as of January 1, Year 1 $112,500 Less payment on December 30, Year 1 $10,000 Less 8% interest on PV of liability (8% x $112,500) (9,000) Equals net payment applied to principal 1,000 Equals liability under lease at December 31, Year 1 $111,500 On January 1 of the current year, Tell Co. leased equipment from Swill Co. under a 9-year sales-type (finance) lease. The equipment had a cost of $400,000 and an estimated useful life of 15 years. Semiannual lease payments of $44,000 are due every January 1 and July 1. The present value of lease payments at 12% was $505,000, which equals the sales price of the equipment. Using the straight-line method, what amount should Tell recognize as depreciation expense on the equipment in the current year? A, $26,667 B. $33,667 C. $44.444 D. $56,111

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Choice "D" is correct. The lessee records the lease as an asset and a liability at the present value of the minimum lease payments. The lease should be depreciated (amortized) over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a written purchase option. Present value of minimum lease payments $505,000 + Lease term 9 = Straight-line depreciation expense ~ $ 56,111 On January 1, Year 1, Moul Mining Co. (lessee), entered into a five-year lease for drilling equipment. Moul accounted for the acquisition as a finance lease for $120,000, which includes a $5,000 purchase option. At the end of the lease, Moul expects to exercise the option. Moul estimates that the equipment's fair value will be $10,000 at the end of its eight-year life. Moul regularly uses straight-line depreciation on similar equipment. For the year ended December 31, Year 1, what amount should Moul recognize as depreciation expense on the leased asset? © A $13,750 B. $15000 C. $23,000 D. $24,000

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Choice "A" is correct. $13,750. Rule: Capitalized equipment should be depreciated in accordance with the lessee’s normal depreciation policy, not to exceed the estimated useful life, if the lease transfers ownership or contains a purchase option. Capitalized value of lease $ 120,000 Less estimated salvage value 10,000 Depreciation base 110,000 Estimated life + 8 years Equals depreciation expense $13,750/year On December 30, Year 1, Rafferty Corp. leased equipment under a finance lease. Annual lease payments of $20,000 are due December 31 for 10 years. The equipment's useful life is 10 years, and the interest rate implicit in the lease is 10%. The finance lease obligation was recorded on December 30 Year 1, at $135,000, and the first lease payment was made on that date. What amount should Rafferty include in current liabilities for this finance lease in its December 31, Year 1 balance sheet? A. $6,500 B. $8,500 c. $11,500 D. $20,000

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Choice "B" is correct. $8,500 finance lease current liability at 12/31/Year 1 (and $106,500 long-term portion) Present value at December 30, Year 1 (start of lease) of 10 payments at 10% $135,000 Less first payment at start of lease (20,000) Equals liability under finance lease at December 30, Year 1 115,000 Payment to be made Dec. 30, Year 2 $20,000 Less 10% interest on PV lease liability (10% x $115,000) (11,500) Equals "current liability” for finance lease at Dec. 31, Year 1 8,500 Total liability under finance lease at 12/31/Year 2 $106,500 Harris Inc. leased equipment under a finance lease for a period of seven years, contracting to pay $100,000 rent in advance at the start of the lease term on December 31, Year 1, and $100,000 annually on December 31 of each of the next six years. The present value at December 31, Year 1, of the seven rent payments over the lease term discounted at 10 percent (the implicit interest rate) was $535,000. Harris amortizes its liability under the lease using the effective interest method. In its December 31, Year 2, balance sheet, Harris should report a lease liability of: © A Cc. $378,500 $391,500 $437,350 $500,000

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Choice "A" is correct. $378,500 lease liability at December 31, Year 2 (end of first year). Present value at Dec 31, Year 1 (start of lease) of 7 payments at 10% $535,000 Less: down payment at start of lease (100,000) Equals: liability under capital (finance) lease at December 31, Year 1 435,000 Less: payment on Dec 31, Year 2 $100,000 Less: 10% interest on PV of liability (435,000 x 10%) (43,500) Net payment applied to principal (56,500) Equals: Liability under capital (finance) lease at December 31, Year 2 $378,500 4 n On December 29, Action Corp. signed a seven-year finance lease for an airplane to transport its sports team around the country. The airplane’s fair value was $841,500. Action made the first annual lease payment of $153,000 on December 31. Action’s incremental borrowing rate was 12 percent, and the interest rate implicit in the lease, which was known by Action, was 9 percent. The following are the rounded present value factors for an annuity due: 9% for 7 years 55 12% for 7 years 5.1 ‘What amount should Action report as a lease liability in its December 31 balance sheet?

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A. $841500 B. $780,300 C. $688,500 D. $627,300 Choice "C" is correct. $688,500. Rule: The present value rate used to value a finance lease is the rate implicit in the lease if known by the lessee. Annual lease payments $153,000 PV of annuity due of 1 for 7 years at 9% x55 Lease liability before 12/31 payment (FMV) 841,500 Less 12/31 payment (153,000) Equals lease liability in 12/31 BS $688,500

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On January 2 of the current year, Cole Co. signed an eight-year noncancelable lease for a new machine, requiring $15,000 annual payments at the beginning of each year. The machine has a useful life of 12 years, with no salvage value. Title passes to Cole at the lease expiration date. Cole use straight-line depreciation for all of its plant assets. Aggregate lease payments have a present value on January 2 of $108,000, based on an appropriate rate of interest. For the current year, Cole should record depreciation (amortization) expense for the leased machine at: A. S0 © B. $9,000 Rule: Capitalized equipment should be depreciated in accordance with the lessee’s normal depreciation policy, not to exceed the estimated useful life, unless the lease does not transfer ownership or contain a bargain purchase option, in which case the shorter lease period should be used Capitalized value of lease $ 108,000 Less estimated salvage valve (0) Depreciable base 108,000 Estimated life* +12 years Depreciation (amortization) expense $ 9,000 Besser Contractors leased a new piece of equipment. The lease is for three years and the economic life of the equipment is four years. The lease contains a written purchase option which Besser intends to exercise. Over how many years should Besser depreciate the leased equipment? A. 2 B. 3 ¢ C. 4 D. The equipment should not be depreciated.

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Explanation Choice "C" is correct. The asset should be depreciated over the period of expected benefit. Since Besser intends to exercise the purchase option, the depreciable period is four years. Choices "A", "B", and "D" are incorrect, per the above discussion. On January 2, Year 1, Nori Mining Co. (lessee) entered into a five-year lease for drilling equipment. Nori accounted for the acquisition as a finance lease for $240,000, which includes a $10,000 written purchase option. At the end of the lease, Nori expects to exercise the purchase option. Nori estimates that the equipment's fair value will be $20,000 at the end of its eight-year life. Nori regularly uses straight-line depreciation on similar equipment. For the year ended December 31, Year 1, what amount should Nori recognize as depreciation expense on the leased asset? A. $48,000 B. $46,000 C. $30,000 D. $27,500 Choice "D" is correct. When a lease is capitalized because of transfer of title or written purchase option, depreciation is based on the life of the asset, not the lease. The cost includes the bargain purchase price. Depreciation cannot be taken below the salvage value. Depreciation is: ($240,000 - 20,000) / 8 years = $27,500

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On January 2, Year 1, Ral Co. leased land and building from an unrelated lessor for a ten-year term. The lease has a renewal option for an additional ten years, but Ral has not reached a decision with regard to the renewal option. In early January of Year 1, Ral completed the following improvements to the property Description Estimated Life Cost Sales office 10 years $47,000 Warehouse 25 years 75,000 Parking lot 15 years 18,000 Amortization of leasehold improvements for Year 2 should be: A. $7,000 B. $8,900 c. $12,200 © D. $14,000

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Choice "D" is correct. $14,000 Rule: Amortization of leasehold improvements should be over the life of the improvements or the remaining life of the lease, whichever is shorter. In this case, the lease term is equal to or less than each category of improvements, accordingly all improvements should be amortized over 10 years. Since there is uncertainty as to whether the lease will be renewed, the renewal option is not a factor. Sales office $47,000 Warehouse 75,000 Parking lot 18,000 $140,000 =10 years = $14,000/year Barnel Corp. owns and manages 19 apartment complexes. On signing a lease, each tenant must pay the first and last months' rent and a $500 refundable security deposit. The security deposits are rarely refunded in total, because cleaning costs of $150 per apartment are almost always deducted. About 30% of the time, the tenants are also charged for damages to the apartment, which typically cost $100 to repair. If a one-year lease is signed on a $900 per month apartment, what amount would Barnel report as refundable security deposit? A. $1,400 © B. $500 Explanation Choice "B" is correct. $500. The entire $500 is recorded as a refundable security deposit. If the tenant moves out at the end of the lease term, the deposit is taken into revenue and matched with the cleaning costs and damage repair and/or refunded to the tenant. The deposit is not revenue upon receipt. On January 1, Year 1, JCK Co. signed a contract for an eight-year lease of its equipment with a 10-year life. The present value of the 16 equal semiannual payments in advance equaled 85 percent of the equipment's fair value. The contract had no provision for JCK, the lessor, to give up legal ownership of the equipment. Should JCK recognize rent or interest revenue in Year 3, and should the revenue recognized in Year 3 be the same or smaller than the revenue recognized in Year 2 under U.S. GAAP?

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Year 3 revenues Year 3 amount recognized recognized compared to Year 2 A. Rent The same B. Rent Smaller c. Interest The same © B8 Interest Smaller Explanation Choice "D" is correct. The lease is a finance lease (lease term is 80 percent of asset life). Interest revenue is recognized for a finance lease, based on the discount rate times the carrying value of the lease receivable. As time passes, the lease receivable decreases and interest revenue recognized also decreases. Winn Co. manufactures equipment that is sold or leased. On December 31, Year 1, Winn leased equipment to Bart for a five-year period ending December 31, Year 6, at which date ownership of the leased asset will be transferred to Bart. Equal payments under the lease are $22,000 and are due on December 31 of each year. The first payment was made on December 31, Year 1. Collectibility of the remaining lease payments is reasonably assured, and Winn has no material cost uncertainties. The normal sales price of the equipment is $77,000, and cost is $60,000. For the year ended December 31, Year 1, what amount of income should Winn realize from the lease transaction? A. $17,000

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Explanation Choice "A" is correct. $17,000 in income recognized for the year ending December 31, Year 1 Rule: In a finance lease, the difference between the fair value of the leased asset and its cost at inception is recognized as a gain or loss. Cash selling price of equipment $77,000 Less cost of equipment at inception 60,000 Profit recognized on sale $17,000 Oak Co. leased equipment for its entire nine-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next eight years. Oak paid $3,000 in initial direct costs at lease inception. The present value on December 31, Year 1, of the nine lease payments over the lease term, using the rate implicit in the lease which Oak knows to be 10 percent was $316,500. On December 31, Year 1, the present value of the lease payments using Oak’s incremental borrowing rate of 12 percent was $298,500. Oak accounts for the finance lease under GAAP and uses straight-line depreciation. What amount should Oak report as ROU asset on its December 31, Year 2, balance sheet? A. $265333 B. $281,333 ¢ C. $284,000 D. $319,500

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Choice "C" is correct. On December 31, Year 1, this lease should be recorded at present value using the known implicit rate of 10 percent. Per GAAP, initial direct costs must be added to the finance lease asset at lease inception. This lease would be recorded using the following journal entry: Debit (Dr) Credit (Cr) ROU asset $319,500 Lease liability $ 316,500 Cash 3,000 The finance lease asset is then amortized over the lease term/useful life of nine years: Annual depreciation = $319,500/9 = $35,500

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On December 31, Year 2, after recording one year of depreciation, the finance lease asset will be reported as: Finance lease asset, 12/31/Y2 Finance lease asset, 12/31/Y1 - Year 2 depreciation $319,500 - $35,500 $284,000 Because the question asks for the asset balance, it is important to remember that the only transaction that reduces the asset value is depreciation. The $50,000 payment made at inception has no impact on the asset value; instead, it reduces the finance lease obligation (Dr. Lease Liability $50,000, Cr. cash $50,000). Glade Co. leases computer equipment to customers under U.S. GAAP direct-financing leases. The equipment has no residual value at the end of the lease and the leases do not contain written purchase options. Glade wishes to ear 8 percent interest on a five-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8 percent for five years is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease? A. $51600 B. $75000 C. $129,360 D. $139,450

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Explanation Choice "A" is correct. The fair value of the equipment is equal the present value of the future cash flows. PV = Annual rents x Annuity due PV factor [n = 5, i = 8%] $323,400 = Annual rents x 4.312 Thus, annual rents = $75,000 Total cash flows = 5 x $75,000 = $375,000 and total interest revenue equals $51,600 [$375,000 total cash flows less $323,400 present value of cash flows] Farm Co. leased equipment to Union Co. on July 1, Year 1, and properly recorded the sales-type (finance) lease at $135,000, the present value of the lease payments discounted at 10%. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, Year 1. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its Year 1 income statement? A. $0 B. $5,500 -~ C. $5750 D. $6,750 Explanation Choice "C" is correct. The initial lease receivable equals $135,000. After the first lease payment is received two days later, the lease receivable equals $115,000 ($135,000 less $20,000). Year 1 interest revenue equals $5,750 ($115,000 x 10% x 6/12).

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In the long-term liabilities section of its balance sheet at December 31, Year 1, Mene Co. reported a finance lease liability of $75,000, net of current portion of $1,364. Payments of $9,000 were made on both January 2, Year 2, and January 2, Year 3. Mene's incremental borrowing rate on the date of the lease was 11 percent and the lessor's implicit rate, which was known to Mene, was 10 percent. In its December 31, Year 2, balance sheet, what amount should Mene report as the lease liability, net of current portion? A. $66,000 B. $73,500 Choice "B" is correct. The lesser of the lessee's incremental borrowing rate or the lessor's implicit rate (if known) should be used. The amortization of the lease is: Cash Interest Principal Lease Date Payment ~ Expense Reduction Obligation 12/31/Year 1 $76,364 1/2/Year 2 $9,000 $7,636 $17364 $75000 12/31/Year 2 $75,000 1/2/Year 3 $9,000 $7,500 $1,500 $73,500 Date Short-Term Long-Term 12/31/Year1 $1,364 $75,000 1/2/Year 2 12/31/Year2 $1,500 $73,500 1/2/Year 3

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Howe Co. leased equipment to Kew Corp. on January 2, Year 1, for an eight-year period expiring December 31, Year 8. Equal payments under the lease are $600,000 and are due on January 2 of each year. The first payment was made on January 2, Year 1. The list selling price of the equipment is $3,520,000 and its carrying cost on Howe's books is $2,800,000. The lease is appropriately accounted for as a sales-type (finance) lease. The present value of the lease payments at an imputed interest rate of 12% (Howe's incremental borrowing rate) is $3,300,000. What amount of profit on the sale should Howe report for the year ended December 31, Year 1? A. $720,000 © B. $500,000 Explanation Choice "B" is correct. The excess of the present value of the selling price over its cost is recorded as profit. Present value of payments $3,300,000 Carrying cost (2,800,000) Profit on sale $ 500,000

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Peg Co. leased equipment from Howe Corp. on July 1, Year 1, for an eight-year period expiring June 30, Year 9. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, Year 1. The rate of interest contemplated by Peg and Howe is 10 percent. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe's accounting records is $2,800,000. The lease is appropriately recorded as a sales-type (finance) lease. What is the amount of profit on the sale and interest revenue that Howe should record for the year ended December 31, Year 1? Profit on Interest Sale Revenue A. $720,000 $176,000 B. $720,000 $146,000 . Choice "B" is correct. $720,000 profit on sale and $146,000 interest revenue. Rule: In a sales-type (finance) lease, any difference between the fair value of the leased asset and its carrying value is recognized as manufacturer's or dealer's profit: Cash selling price of equipment $ 3,520,000 Less cost of equipment (2,800,000) Profit recognized on sale $ 720,000

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Rule: Unearned interest revenue in a sales-type lease is amortized over the period of the lease using the interest method PV at inception of the lease at 7/1/Year 1 $3,520,000 Less initial payment 7/1/Year 1 (600,000) Balance during first year 2,920,000 Interest rate x 10% Interest revenue 7/1/Year 1 to 6/30/Year 2 (12 months) 292,000 Adjust from full year to half year X% yr Interest revenue for year end 12/31/Year 1 $ 146,000

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F6 m2 questions leases

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