CHAPTER 12 Financial Reporting for Leases
d. Cash receipts from leases are shown in the operating activities section of the statement of cash
flows.
89. The most straightforward method for making lessees’ balance sheet data comparable is to treat
all leases as if they were
a. operating leases.
b. capital leases.
c. direct financing capital leases.
d. sales-type capital leases.
90. Which of the following is a reason why lease accounting under U.S. GAAP and IFRS were re-
vised?
a. It was too easy for firms to circumvent lease capitalization criteria.
b. To enhance comparability for analyzing different companies’ financial statements.
c. Operating leases were a popular means of off-balance sheet financing.
d. All of these answer choices are correct.
91. Under international accounting standard IAS 17, which of the following is an indicator of a situa-
tion (individually or in combination) that could lead to a lease being classified as a finance lease?
a. If the lessor can cancel the lease, the lessee’s losses associated with the cancellation are borne
by the lessor.
b. The lessee has the ability to continue the lease for a secondary period at a rent that is substan-
tially lower than market rent.
c. Gains or losses from the fluctuation in the fair value of the residual accrue to the lessor.
d. The leased assets are of such a nature that any other lessee could use such assets without modi-
fication
92. Under international accounting standard IAS 17, which of the following is a correct answer
choice?
a. Disclosure of lessee future minimum lease payments for the periods within one year, within
years two through five, and after five years are required.
b. Lessees can classify some assets held under leases as investment property.
c. The two additional lessor criteria provided under U.S. GAAP for lease revenue recognition are
absent.
d. All of these are correct answer choices.
93. Which of the following is a correct statement regarding lessor accounting regulations under ASC
842?
a. If a lease meets any one of the five lessee classification criteria under ASU 2016-02 and if there
is dealer profit, the profit is recognized as cash is collected.
b. If a lease meets any one of the five lessee classification criteria under ASU 2016-02, regardless
of whether there is dealer profit, the lease is classified as a sales-type lease.
c. If collectiblility of a lease is not probable, then the lessor treats it as an operating lease.
CHAPTER 12 Financial Reporting for Leases
d. If collectibility of the lease is not probable, then the lessor is required to remove the asset from
its balance sheet.
94. Under international accounting standard IAS 17, a lessee may classify some assets held under
leases as investment property which allows the lessee to
a. Avoid recording depreciation expense for the assets.
b. Account for the assets using either historical cost or fair value.
c. Use the higher of the implicit or the incremental borrowing rate when computing the present
value of the minimum lease payments.
d. Account for such assets under operating leases.
95. All of the following are true of constructive capitalization except
a. it’s a method for making balance sheet data historically correct.
b. it treats all leases as if they were capital leases.
c. the liability is the discounted present value of the stream of minimum operating lease pay-
ments.
d. the method makes use of a discount rate that is the weighted average rate implicit in all leases,
or the weighted average rate on interest-bearing long-term debt.
96. Goff Industries has applied for a loan and, as the bank loan officer, you’ve been assigned to
evaluate Goff’s financial statements. Your evaluation reveals that Goff has no capital leases record-
ed on its financial statements while most other companies in its industry do have such leases. To ef-
fectively evaluate Goff’s financial position and compare it to industry standards, you’ve decided to
constructively capitalize Goff’s operating leases. The following information is available from Goff’s
financial statements for the year ended December 31, 2018: (Round all intermediate calculations to
the nearest whole dollar.)
Minimum operating lease payments:
2019 $1,000
2020 900
2021 820
2022 760
2023 700
2024 – 2027 2,500
Assuming Goff’s long-term debt rate is 10%, what amount would you constructively capitalize in
order to effectively analyze Goff’s financial position?
a. $ – 0 – since the company has no capital leases.
b. $6,680
c. $11,504.
d. $3,223.
Essay and Computational Questions
97. On October 1, 2018, Kelly Company leased a boat from Grant Company. The lease is noncan-
celable and requires five equal annual payments of $50,000 each. The lease payments are due each
CHAPTER 12 Financial Reporting for Leases
October 1, beginning October 1, 2018. The boat is recorded on Grant’s books at $180,000, but its
fair value is $207,542. Grant expects that the boat’s residual value at the end of the lease term will
be $10,000, but it is not guaranteed by Kelly. However, Kelly has an option to purchase the boat for
$10,000 at the end of the lease term. At the inception of the lease, the boat has a remaining econom-
ic life of six years with a $2,500 estimated salvage value at the end of its life. Both firms use the
straight-line method of depreciation and have December 31 year-ends for financial reporting pur-
poses. The interest rate used by Grant Company to calculate the annual lease payment is 12%, and
known by Kelly. Collection of the lease payments is reasonably predictable by Grant. Both compa-
nies use ASC 840 for lease accounting.
Required:
1. Complete the following table for Grant’s and Kelly’s December 31, 2018 income state-
ments:
Grant (Lessor) Kelly (Lessee)
Sales
Interest income
Rent revenue
Cost of goods sold
Depreciation expense
Rent expense
Interest expense
Be sure to show and clearly label all calculations.
Answer:
Interest income .12 (207,542 – 50,000) 3/12 = 4,726 0
CHAPTER 12 Financial Reporting for Leases
98. Fischer Corporation leased new equipment to Swix Company on January 1, 20X1. The lease is
for an eight-year period and requires equal annual payments of $35,000 due on January 1 of each
year. The first payment was made at the inception of the lease. The fair value of the equipment and
the present value of the payments was $217,223. The implicit interest rate is 8%. The equipment
cost Fischer Corporation $160,000, has an estimated eight-year life, and a residual value of zero.
Fischer Corporation uses straight-line depreciation. Fischer Corporation should have recorded the
lease as a sales-type lease but mistakenly recorded the lease as an operating lease.
Required: Determine the amount of the lease classification error on the following financial state-
ment elements of Fischer Corporation, and whether the amount is overstated or understated:
1) Net Income for the year ended 12/31/X1 ____________
2) Total assets as of 12/31/X2 ____________
Answer:
99. Conroy Company leased equipment on January 1, 2018 and accounts for it under ASC 840. In-
formation pertinent to the lease is as follows:
• The lease term is 6 years.
• Annual payments of $60,000 are due on January 1 of each year; the first payment
was made at the inception of the lease.
• Conroy’s incremental borrowing rate is 12%.
• The implicit interest rate is 10%; Conroy knew the implicit interest rate.
CHAPTER 12 Financial Reporting for Leases
• The unguaranteed residual value is $50,000.
• The useful life of the equipment is 10 years.
• Conroy uses the straight-line depreciation method.
• The fair value of the equipment is $325,000.
• The lease agreement did not contain either a bargain purchase option or a transfer
of title.
Required:
Prepare all the necessary journal entries for the year ended December 31, 2018 with respect to
Conroy Company’s lease.
100. On January 1, 2018, Cole Corporation entered into a ten-year lease agreement. Cole accounts
for its leases under ASC 840. The following summarizes the agreement:
• Payments of $30,000 are due at the beginning of each year; the first payment was made
on January 1, 2018.
• The leased asset has an estimated useful life of 15 years.
• Title to the leased asset is transferred to Cole at the end of the lease term.
• The implicit interest rate known by Cole is 10%.
• Cole’s incremental borrowing rate is 12%.
• Cole uses the straight-line depreciation method.
• The asset’s estimated salvage value is $50,000 after 10 years and is $15,000 after 15
years.
Required:
1. Determine the interest expense associated with the lease for the year ended December 31, 2018.
2. Determine the depreciation expense for the year ended December 31, 2018.
CHAPTER 12 Financial Reporting for Leases
Answer:
101. On January 1, 2019, Coleus Corporation entered into a ten-year lease agreement. Coleus ac-
counts for its leases under ASC 842. The following summarizes the agreement:
• Payments of $30,000 are due at the beginning of each year; the first payment was made
on January 1, 2019.
• The leased asset has an estimated useful life of 15 years.
• Title to the leased asset is transferred to Coleus at the end of the lease term.
• The implicit interest rate known by Coleus is 10%.
• Coleus’s incremental borrowing rate is 12%.
• Coleus uses the straight-line depreciation method.
• The asset’s estimated salvage value is $50,000 after 10 years and is $15,000 after 15
years.
Required:
1. Determine the interest expense associated with the lease for the year ended December 31, 2019.
2. Determine the amortization expense for the year ended December 31, 2019.
Answer:
AACSB: Knowledge Application
CHAPTER 12 Financial Reporting for Leases
AICPA: BB Critical Thinking
AICPA: FN Measurement
Blooms: Apply
Topic: ASC 842―Lessee accounting
102. Flat Iron Corporation, a lessor, entered into a lease agreement on November 1, 2018. The lease
was for 6 years and required the lessee to make annual payments of $187,800 on November 1st of
each year; the first payment was received by Flat Iron on November 1, 2018. The leased asset cost
Flat Iron $600,000, the implicit interest rate was 9%, and the asset’s useful life was 6 years. There
were not any uncertainties regarding the collection of the lease payments and Flat Iron’s perfor-
mance was considered to be complete as of November 1, 2018. Flat Iron accounts for leases under
ASC 840.
Required
1. Determine the amount of income that will be reported by Flat Iron for the year ended Decem-
ber 31, 2018.
2. Prepare the necessary journal entries for the year ended December 31, 2018.
Answer:
103. On January 1, 2018, Avalanche Company entered into an agreement to lease equipment for a
ten-year period. The lease requires Avalanche to pay $220,000 on January first of each year, with
the first payment required at the lease inception. Included within the $220,000 annual payment are
executory costs totaling $15,000. Avalanche has the option to purchase the equipment at the end of
the lease term for $55,000; the fair value of the equipment at the end of the lease term is estimated to
be $120,000. The equipment’s useful life is estimated to be 12 years and the salvage value after 12
years is estimated to be $10,000. Avalanche’s incremental borrowing rate is 8% and the implicit rate
known by Avalanche is 7%. Avalanche accounts for leases under ASC 840.
Required:
1. Determine the lease liability immediately after the January 1, 2019 payment was made.
2. Determine the book value of the leased asset as of December 31, 2019.
3. Determine the total expenses to be reported on the income statement for the year ended De-
cember 31, 2019.
Answer:
104. On July 1, 2018, Colby Company sold equipment to Cheddar Corporation and simultaneously
leased it back for five years. The equipment’s fair value on July 1, 2018 was $875,000 and its book
value was $700,000. Colby and Cheddar agreed to an 8% interest rate with respect to the lease
transaction. The equipment has a remaining life of five years and an estimated salvage value of zero
after five years. Colby is required to make annual payments of $202,916 beginning July 1, 2018.
Required:
Prepare the necessary journal entries for Colby Company to record the sale-leaseback at July 31,
2018, and for the year ended December 31, 2018. Assume that the lease qualifies as a capital lease
from Colby’s perspective. Colby accounts for leases under ASC 840.
Answer:
105. On July 1, 2019, Colber Company sold equipment to Chopper Corporation and simultaneously
leased it back for five years. The equipment’s fair value on July 1, 2019 was $875,000. Its original
cost to Colber was $1,000,000 and it was being depreciated over 10 years on a straight-line basis.
Colber has owned the equipment of three years and its book value was $700,000. Colber and Chop-
per agreed to an 8% interest rate with respect to the lease transaction. The equipment has a remain-
CHAPTER 12 Financial Reporting for Leases
ing life of five years and an estimated salvage value of zero after five years. Colber is required to
make annual payments of $202,916 beginning July 1, 2019.
Required:
Prepare the necessary journal entries for Colber Company to record the sale-leaseback for the year
ended December 31, 2019. Assume that the lease qualifies as a capital lease from Colber’s perspec-
tive. Colber accounts for leases under ASC 842.
106. Describe the criteria that the lessor must utilize when determining whether a lease is to be treat-
ed as a capital lease or as an operating lease according to ASC 840.
Answer:
CHAPTER 12 Financial Reporting for Leases