Intermediate Accounting Kieso 16e Test Bank 21.1
TRUE-FALSE—Conceptual
1. Leasing equipment reduces the risk of obsolescence to the lessee and in many cases passes the risk of residual value to the lessor.
2. The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases.
3. Minimum rental payments are the same as minimum lease payments.
4. Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.
5. A capitalized leased asset is always depreciated over the term of the lease by the lessee.
6. A lessee records interest expense in both a capital lease and an operating lease.
7. A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.
8. The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title.
9. Lessors classify and account for all leases that do not qualify as sales-type leases as operating leases.
10. Direct-financing leases are in substance the financing of an asset purchase by the lessee.
11. Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.
12. In computing the annual lease payments, the lessor deducts only a guaranteed residual value from the fair value of a leased asset.
13. When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value, that stated amount is the guaranteed residual value.
14. Both a guaranteed and an unguaranteed residual value affect the lessee’s computation of amounts capitalized as a leased asset.
15. From the lessee’s viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments.
16. The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed.
17. The primary difference between a direct-financing lease and a sales-type lease is the manufacturer’s or dealer’s gross profit (or loss).
18. The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.
19. Companies must periodically review the estimated unguaranteed residual value in a sales-type lease.
20. The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.
MULTIPLE CHOICE—Conceptual
21. Which of the following are reasons why a company is involved in leasing to other companies?
I. Interest revenue.
II. High residual values.
III. Tax incentives.
IV. Guaranteed bargain purchase options.
a. I, II, IV.
b. II, III, and IV.
c. I, III, and IV.
d. I, II, and III.
22. Which of the following is an advantage of captive leasing companies over the other players in the leasing market?
a. They have access to low-cost funds allowing them to purchase assets at lower cost.
b. They are good at developing innovative contracts that help avoid accounting problems.
c. They provide leasing arrangements for a wider range of products than the parent company’s product line.
d. They have the point-of-sale advantage in finding leasing customers.
23. Which of the following best describes current practice in accounting for leases?
a. Leases are not capitalized.
b. Leases similar to installment purchases are capitalized.
c. All long-term leases are capitalized.
d. All leases are capitalized.
24. While only certain leases are currently accounted for as a sale or purchase, there is theoretical justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that
a. all leases are generally for the economic life of the property and the residual value of the property at the end of the lease is minimal.
b. at the end of the lease the property usually can be purchased by the lessee.
c. a lease reflects the purchase or sale of a quantifiable right to the use of property.
d. during the life of the lease the lessee can effectively treat the property as if it were owned.
S25. An essential element of a lease is that the
a. lessor conveys less than his or her total interest in the property.
b. lessee provides a sinking fund equal to one year’s lease payments.
c. property that is the subject of the lease agreement must be held for sale by the lessor prior to the drafting of the lease agreement.
d. term of the lease is substantially equal to the economic life of the leased property.
S26. What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?
a. There is no impact as the option does not enter into the transaction until the end of the lease term.
b. The lessee must increase the present value of the minimum lease payments by the present value of the option price.
c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price.
d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.
P27. The amount to be recorded as the cost of an asset under capital lease is equal to the
a. present value of the minimum lease payments.
b. present value of the minimum lease payments or the fair value of the asset, whichever is lower.
c. present value of the minimum lease payments plus the present value of any unguaranteed residual value.
d. carrying value of the asset on the lessor’s books.
28. The methods of accounting for a lease by the lessee are
a. operating and capital lease methods.
b. operating, sales, and capital lease methods.
c. operating and leveraged lease methods.
d. None of these answers are correct.
29. Which of the following is a correct statement of one of the capitalization criteria?
a. The lease transfers ownership of the property to the lessor.
b. The lease contains a purchase option.
c. The lease term is equal to or more than 75% of the estimated economic life of the leased property.
d. The minimum lease payments (excluding executory costs) equal or exceed 90% of the fair value of the leased property.
30. Minimum lease payments may include:
I. a penalty for failure to renew.
II. executory costs.
III a bargain purchase option.
IV. a guaranteed residual value.
a. I, II, and III.
b. II, III, and IV.
c. I, II, and IV.
d. I, III, and IV.
31. In computing depreciation of a leased asset, the lessee should subtract
a. a guaranteed residual value and depreciate over the term of the lease.
b. an unguaranteed residual value and depreciate over the term of the lease.
c. a guaranteed residual value and depreciate over the life of the asset.
d. an unguaranteed residual value and depreciate over the life of the asset.
32. In computing the present value of the minimum lease payments, the lessee should
a. use its incremental borrowing rate in all cases.
b. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee.
c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee.
d. use the implicit rate in all cases.
33. Lessees prefer to account for their leases as operating lease because:
a. this increases their debt to total equity ratio.
b. this decreases the income tax expense.
c. this increases the amount of total assets.
d. this decreases the amount of liability reported.
34. From the lessee’s perspective, in the earlier years of a lease, the use of the
a. capital method will enable the lessee to report higher income, compared to the operating method.
b. capital method will cause debt to increase, compared to the operating method.
c. operating method will cause income to decrease, compared to the capital method.
d. operating method will cause debt to increase, compared to the capital method.
P35. A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the
a. asset’s remaining economic life.
b. term of the lease.
c. life of the asset or the term of the lease, whichever is shorter.
d. life of the asset or the term of the lease, whichever is longer.
36. Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor?
Transfers Ownership Contains Bargain Collectibility of Lease Any Important
by End of Lease? Purchase Option? Payments Assured? Uncertainties?
a. No Yes Yes No
b. Yes No No No
c. Yes No No Yes
d. No Yes Yes Yes
37. Which of the following would be included in the Lease Receivable account?
I. Guaranteed residual value.
II. Unguaranteed residual value.
III. Executory costs
IV. Penalty for failure to renew.
a. I and III only.
b. II, III, and IV.
c. I and II only.
d. I, II, and IV.
38. In a lease that is appropriately recorded as a direct-financing lease by the lessor, the unearned income
a. should be amortized over the period of the lease using the effective interest method.
b. should be amortized over the period of the lease using the straight-line method.
c. does not arise.
d. should be recognized at the lease’s expiration.
S39. In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as
a. the amount of funds the lessor has tied up in the asset which is the subject of the direct-financing lease.
b. the difference between the lease payments receivable and the fair value of the leased property.
c. the present value of minimum lease payments.
d. the total book value of the asset less any accumulated depreciation recorded by the lessor prior to the lease agreement.
S40. If the residual value of a leased asset is guaranteed by a third party
a. it is treated by the lessee as no residual value.
b. the third party is also liable for any lease payments not paid by the lessee.
c. the net investment to be recovered by the lessor is reduced.
d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.
41. When lessors account for residual values related to leased assets, they
a. include the residual value because it is assumed the residual value will be realized.
b. include the unguaranteed residual value in sales revenue.
c. recognize more gross profit on a sales-type lease with a guaranteed residual value than on a sales-type lease with an unguaranteed residual value.
d. reduce the residual value by the executory costs.
42. The initial direct costs of leasing
a. are generally borne by the lessee.
b. include incremental costs related to internal activities of leasing, and internal costs related to costs paid to external third parties for originating a lease arrangement.
c. are expensed in the period of the sale under a sales-type lease.
d. include lessor advertising costs.
S43. The primary difference between a direct-financing lease and a sales-type lease is the
a. manner in which rental receipts are recorded as rental income.
b. amount of the depreciation recorded each year by the lessor.
c. recognition of the manufacturer’s or dealer’s profit at (or loss) the inception of the lease.
d. allocation of initial direct costs by the lessor to periods benefited by the lease arrangements.
P44. A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts?
a. The minimum lease payments plus the unguaranteed residual value.
b. The present value of the minimum lease payments.
c. The cost of the asset to the lessor, less the present value of any unguaranteed residual value.
d. The present value of the minimum lease payments plus the present value of the unguaranteed residual value.
45. For a sales-type lease,
a. the sales price includes the present value of the unguaranteed residual value.
b. the present value of the guaranteed residual value is deducted to determine the cost of goods sold.
c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed.
d. assets are depreciated by the lessor.
46. Which of the following statements is correct?
a. For direct-financing leases, initial direct costs are added to the net investment in the lease.
b. For sales-type leases, initial direct costs are expensed in the year of incurrence.
c. For operating leases, initial direct costs are deferred and allocated over the lease term.
d. For sales-type leases, lessor revisions in estimated unguaranteed residual values can take the form of both upward and downward adjustments.
47. The Lease Liability account should be disclosed as
a. a current liability.
b. a noncurrent liability.
c. current portions in current liabilities and the remainder in noncurrent liabilities.
d. deferred credits.
48. To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal?
a. Lessee uses a higher interest rate than that used by lessor.
b. Set the lease term at something less than 75% of the estimated useful life of the property.
c. Write in a bargain purchase option.
d. Use a third party to guarantee the asset’s residual value.
*49. If the lease in a sale-leaseback transaction meets one of the four leasing criteria and is therefore accounted for as a capital lease, who records the asset on its books and which party records interest expense during the lease period?
Party recording the Party recording
asset on its books interest expense
a. Seller-lessee Purchaser-lessor
b. Purchaser-lessor Seller-lessee
c. Purchaser-lessor Purchaser-lessor
d. Seller-lessee Seller-lessee
*50. If none of the four leasing criteria are satisfied in a sale-leaseback transaction, which of the following statements is incorrect?
a. The seller-lessee removes the asset from its books.
b. The purchaser-lessor records a gain.
c. The seller-lessee records the lease as an operating lease.
d. The seller-lessee amortizes deferred profit or loss in proportion to the rental payments over operating lease asset period.
*51. When a company sells property and then leases it back, any gain on the sale should usually be
a. recognized in the current year.
b. recognized as a prior period adjustment.
c. recognized at the end of the lease.
d. deferred and recognized as income over the term of the lease.
MULTIPLE CHOICE—Computational
52. On December 1, 2018, Goetz Corporation leased office space for 10 years at a monthly rental of $80,000. On that date Goetz paid the landlord the following amounts:
Rent deposit $ 80,000
First month’s rent 80,000
Last month’s rent 80,000
Installation of new walls and offices 640,000
$880,000
The entire amount of $880,000 was charged to rent expense in 2018. What amount should Goetz have charged to expense for the year ended December 31, 2018?
a. $80,000
b. $85,333
c. $165,333
d. $640,000
53. On January 1, 2018, Dean Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Dean to make annual payments of $220,000 at the end of each year for ten years with the title passing to Dean at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Dean uses the straight-line method of depreciation for all of its fixed assets. Dean accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $1,342,016 at an effective interest rate of 8%. With respect to this capitalized lease, Dean should record for 2018
a. lease expense of $200,000.
b. interest expense of $89,468 and depreciation expense of $76,136.
c. interest expense of $107,361 and depreciation expense of $89,468.
d. interest expense of $91,363 and depreciation expense of $134,202.
Use the following information for questions 54 through 59. (Annuity tables on page 21-30.)
On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the beginning each year.
(b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Yancey’s incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc.
(f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property.
54. What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.)
a. $272,703
b. $872,703
c. $887,703
d. $902,703
55. What is the amount of the total annual lease payment?
a. $272,703
b. $872,703
c. $887,703
d. $902,703
56. From the lessee’s viewpoint, what type of lease exists in this case?
a. Sales-type lease
b. Sale-leaseback
c. Capital lease
d. Operating lease
57. From the lessor’s viewpoint, what type of lease is involved?
a. Sales-type lease
b. Sale-leaseback
c. Direct-financing lease
d. Operating lease
58. Yancey, Inc. would record depreciation expense on this storage building in 2018 of (Rounded to the nearest dollar.)
a. $0.
b. $495,000.
c. $600,000.
d. $976,471.
59. If the lease was nonrenewable, there was no bargain purchase option, title to the building does not pass to the lessee at termination of the lease and the lease term was only for eight years, what type of lease would this be for the lessee?
a. Sales-type lease
b. Direct-financing lease
c. Operating lease
d. Capital lease
60. Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets the criteria to be a capital 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 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Metcalf should record the leased asset at
a. $848,761.
b. $814,435.
c. $723,943.
d. $694,665.
61. On December 31, 2018, Lang Corporation leased a ship from Fort Company for an eight-year period expiring December 30, 2026. Equal annual payments of $500,000 are due on December 31 of each year, beginning with December 31, 2018. The lease is properly classified as a capital lease on Lang ‘s books. The present value at December 31, 2018 of the eight lease payments over the lease term discounted at 10% is $2,934,213. Assuming all payments are made on time, the amount that should be reported by Lang Corporation as the total obligation under capital leases on its December 31, 2019 balance sheet is
a. $2,727,635.
b. $2,500,397.
c. $2,177,634.
d. $3,000,000.
On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%.
62. In 2018, Sauder should record interest expense of
a. $63,397.
b. $116,604.
c. $83,396.
d. $136,604.
On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%.
63. In 2019, Sauder should record interest expense of
a. $43,397.
b. $49,737.
c. $69,737.
d. $63,397.
64. On December 31, 2018, Kuhn Corporation leased a plane from Bell Company for an seven-year period expiring December 31, 2025. Equal annual payments of $450,000 are due on December 31 of each year, beginning with December 31, 2018. The lease is properly classified as a capital lease on Kuhn’s books. The present value at December 31, 2018 of the eight lease payments over the lease term discounted at 10% is $2,640,792. Assuming the first payment is made on time, the amount that should be reported by Kuhn Corporation as the lease liability on its December 31, 2018 balance sheet is
a. $2,640,792.
b. $2,454,870.
c. $2,376,714.
d. $2,190,792.
On January 1, 2018, Ogleby Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Ogleby to make annual payments of $180,000 at the beginning of each year for five years with title passing to Ogleby at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Ogleby uses the straight-line method of depreciation for all of its fixed assets. Ogleby accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $750,578 at an effective interest rate of 10%.
65. With respect to this capitalized lease, for 2018 Ogleby should record
a. rent expense of $180,000.
b. interest expense of $57,058 and depreciation expense of $150,116.
c. interest expense of $57,058 and depreciation expense of $107,225.
d. interest expense of $90,000 and depreciation expense of $181,956.
On January 1, 2018, Ogleby Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Ogleby to make annual payments of $180,000 at the beginning of each year for five years with title passing to Ogleby at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Ogleby uses the straight-line method of depreciation for all of its fixed assets. Ogleby accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $750,578 at an effective interest rate of 10%.
66. With respect to this capitalized lease, for 2019 Ogleby should record
a. interest expense of $57,058 and depreciation expense of $107,225.
b. interest expense of $75,058 and depreciation expense of $107,225.
c. interest expense of $44,764 and depreciation expense of $107,225.
d. interest expense of $62,764 and depreciation expense of $107,225.
67. Emporia Corporation is a lessee with a capital lease. The asset is recorded at $900,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a fair value of $300,000 at the end of 5 years, and a fair value of $100,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease?
a. $180,000
b. $160,000
c. $120,000
d. $100,000
68. Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. If Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%, what is the amount recorded for the leased asset at the lease inception?
PV Annuity Due PV Ordinary Annuity
8%, 4 periods 3.57710 3.31213
10%, 4 periods 3.48685 3.16986
a. $1,231,066
b. $1,090,912
c. $1,139,874
d. $1,200,000
69. Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of interest expense recorded by Pisa, Inc. in the first year of the asset’s life?
PV Annuity Due PV Ordinary Annuity
8%, 4 periods 3.57710 3.31213
10%, 4 periods 3.48685 3.16986
a. $0
b. $98,482
c. $70,953
d. $91,192
70. Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of principal reduction recorded when the second lease payment is made in Year 2?
PV Annuity Due PV Ordinary Annuity
8%, 4 periods 3.57710 3.31213
10%, 4 periods 3.48685 3.16986
a. $344,152
b. $245,666
c. $252,960
d. $273,199
