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Chapter 15 Leases
148. Peridot Leasing entered into an agreement to lease warehouses to AMC Foods.
a. The agreement calls for ownership of the aircraft to be transferred to AMC Foods at the
end of the lease term.
b. The fair value of the warehouses is expected to be $400,000 at the end of the lease term.
AMC has the option to purchase the warehouses at the end of the lease term for $80,000.
c. The warehouses have a useful life of 10 years and the term of the lease is 7 years.
d. The present value of the lease payments is $4,400,000 and the fair value of the leased
warehouses is $5,000,000.
e. The warehouses were manufactured to meet specifications provided by AMC to optimize
its food delivery processes.
Required:
1. In each independent scenario, indicate whether AMC would classify the lease as an
operating lease or finance lease under U.S. GAAP. Assume the lease agreement has not
met any of the other indicators of a finance lease. Provide brief explanations.
2. In each independent scenario, indicate whether AMC would classify the lease as an
operating lease or finance lease under International Financial Reporting Standards IAS 17.
Assume the lease agreement has not met any of the other indicators of a finance lease.
Provide brief explanations.
Answer:
1. U.S. GAAP
2. IFRS
Chapter 15 Leases
Respond to questions 149–156 with the presumption that the guidance provided by the new
Accounting Standards Update is being applied.
149. KateCo leased a warehouse from Big Dave Industries on July 1, 2016, in a Type A lease. The
present value of the lease payments discounted at 10% was $160,000. Ten annual lease
payments of $24,000 are due each July1, beginning July 1, 2016. Big Dave had constructed
the equipment recently for $132,000 and its retail fair value was $160,000.
Required:
Following the guidance of the new ASU, and assuming that KateCo obtains “control” of the
warehouse, prepare the two journal entries to record the lease by Big Dave at July 1, 2016.
Answer:
150. Neely BBQ leased equipment from Smoke Industries on January 1, 2016. Smoke Industries
had manufactured the equipment at a cost of $810,000. Both companies employ the lease
ASU.
Other information:
Lease term 4 years
Chapter 15 Leases
Annual payments $360,000 beginning Jan. 1, 2016, and at Dec. 31, 2016,
2017, and 2018
Life of asset 4 years
Rate the lessor charges 8%
Required:
1. Prepare the appropriate entries for Neely BBQ (Lessee) on January 1, 2016, and
December 31, 2016.
2. Prepare the appropriate entries for Smoke Industries (Lessor) on January 1, 2016, and
December 31, 2016. Assume that the risks and rewards of ownership are assumed
transferred to the lessee.
3. Prepare the appropriate entries for Smoke Industries (Lessor) on January 1, 2016, and
December 31, 2016. Assume that the risks and rewards of ownership are assumed not to
have been transferred to the lessee..
Answer:
Chapter 15 Leases
Chapter 15 Leases
151. You and a colleague are reviewing a prospective lease transaction for your employer, Ma and
Pa Kettle’s (MPK). Having heard of the new lease accounting standard update, your CFO has
assigned you the task of assessing the impact of the lease transactions on the company’s
financial statements. The terms are these: At the beginning of its fiscal year, MPK would lease
restaurant space from Wilson Corporation under a 10-year lease agreement. The contract calls
for annual lease payments of $25,000 each at the end of each year. The building was acquired
last week by Wilson at a cost of $300,000 and is expected to have a useful life of 25 years
with no residual value for calculating straight-line depreciation. Wilson seeks a 10% return on
its lease investments.
Required:
What will be the effect of the lease on MPK’s earnings for the first year, and on the balance
sheet at the end of the year (ignore taxes)? Journal entries are not required but might be
helpful in your assessment.
Answer:
Chapter 15 Leases
Chapter 15 Leases
152. Nickle leased equipment to Back Company on July 1, 2016. Lease payments of $18,000
are due each year beginning July 1, 2016. The present value of the lease payments
discounted at 10% was $120,000. The asset’s useful life is 12 years. Nickle acquired this
equipment for $120,000 on July 1, 2016 for the purpose of this lease.
Required:
1. Following the guidance of the new ASU, prepare the journal entries to record the lease
by Nickle (lessor) at July 1, 2016, and at December 31, 2016, the end of its fiscal year.
Assume the risks and rewards of ownership were presumed transferred to the lessee.
2. Following the guidance of the new ASU, prepare the journal entries to record the lease
by Nickle (lessor) at July 1, 2016, and at December 31, 2016, the end of its fiscal year.
Assume the risks and rewards of ownership were presumed not to have been
transferred to the lessee.
Answer:
Chapter 15 Leases
153. Big Bucks leased equipment to Shannon Company on July 1, 2016. The lease payments were
calculated to provide the lessor a 10% return. Ten annual lease payments of $36,000 are due
each July 1, beginning July 1, 2016.
Required:
1. Following the guidance of the new ASU, prepare the journal entries to record the lease by
Shannon at July 1, 2016, and at December 31, 2016, the end of the reporting period.
Assume the risks and rewards of ownership were presumed to have been transferred to the
lessee.
2. Following the guidance of the new ASU, prepare the journal entries to record the lease by
Shannon at July 1, 2016, and at December 31, 2016, the end of the reporting period.
Assume the risks and rewards of ownership were presumed not to have been transferred to
the lessee.
Answer:
Chapter 15 Leases
154. Deal Leasing leased equipment to Hand Company on January 1, 2016. The lease payments
were calculated to provide the lessor a 10% return. Ten annual lease payments of $60,000 are
due at the beginning of each year beginning January 1, 2016. The present value of an annuity
due of 1 at 10 for ten periods is 6.75902. Assume the risks and rewards of ownership were
presumed to have been transferred to the lessee.
Required:
Following the guidance of the new ASU, prepare the journal entries to record the lease by
Hand (lessee) at January 1, 2016, and at December 31, 2016, the end of the reporting
period.
155. Deal Leasing leased equipment to Hand Company on January 1, 2016. The lease payments
were calculated to provide the lessor a 10% return. Ten annual lease payments of $60,000 are
due at the beginning of each year beginning January 1, 2016. The lease payments were
calculated to provide the lessor a 10% return. The present value of an annuity due of 1 at 10
for ten periods is 6.75902. Assume the risks and rewards of ownership were presumed not to
have been transferred to the lessee.
Required:
Following the guidance of the new ASU, prepare the journal entries to record the lease by
Hand (lessee) at January 1, 2016, and at December 31, 2016, the end of the reporting
period.
Answer:
156. Big Bucks leased equipment to Shannon Company on January 1, 2016. The lease payments
were calculated to provide the lessor a 10% return. Ten annual lease payments of $20,000 are
due at the beginning of each year beginning January 1, 2016. The present value of an annuity
due of 1 at 10 for ten periods is 6.75902.
Required:
1. Following the guidance of the new ASU, prepare the journal entries to record the lease by
Shannon at January 1, 2016, and at December 31, 2016, the end of the reporting period.
Assume the risks and rewards of ownership were presumed to have been transferred to the
lessee.
2. Following the guidance of the new ASU, prepare the journal entries to record the lease by
Shannon at January 1, 2016, and at December 31, 2016, the end of the reporting period.
Assume the risks and rewards of ownership were presumed not to have been transferred to
the lessee.
Chapter 15 Leases
Essay
Instructions:
The following answers point out the key phrases that should appear in students' answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.
157. What is meant by the term "minimum lease payments"?
158. Discuss the financial statement disclosure requirements for all leases entered into by the
lessee.
159. Discuss the three major types of leases that may apply to the lessor. How do they differ?
160. Discuss the economic advantages of leasing.
161. Describe the use of depreciation for an asset leased under a capital lease. Include a discussion
of the depreciation period.
162. What is a bargain purchase option and when do the parties to a lease know if it exists?
163. Differentiate between guaranteed and unguaranteed residual value of leased property. Does
the difference affect the lessor’s accounting for the lease?
164. Discuss the interest rates used by the lessee and the lessor for determining the present value of
a capital lease.
165. In a lease transaction, what are initial direct costs? How do we account for initial direct costs
in an operating lease, a direct financing lease, and a sales-type lease?
166. What lease disclosures are required of the lessor and lessee?
167. How do U.S. GAAP and International Financial Reporting Standards (IFRS) differ with
respect to recognizing a gain on a sale and leaseback transaction?
Chapter 15 Leases
168. In its 2016 annual report to shareholders, Douglas-Roberts International Corporation disclosed
the following:
In 2016, the company entered into three sale-leaseback arrangements with various financial
institutions. Under the first arrangement, truck cab assembly machinery with a net book value
of $58 million was sold for $60 million and leased back under an eight-year operating lease
agreement. Under the second arrangement, tooling and related engine manufacturing
equipment with a net book value of $261 million was sold for $260 million and leased back
under an 11.5-year operating lease agreement. The third arrangement consisted of additional
engine manufacturing equipment with a net book value of $62 million that was sold for $65
million and leased back under a 10-year operating lease agreement. The gain on these
transactions was deferred and is being amortized over the terms of the lease agreements.
Discuss the most likely reasons for these three transactions, and explain the basis for the last
sentence of the disclosure.
169. Hamilton Security leased equipment to American Parcel Service for a 16-year period, at which
time possession of the leased asset will revert back to Hamilton. The equipment cost Hamilton
$16 million and has an expected useful life of 22 years. Its normal sales price is $23 million.
The present value of the minimum lease payments for both the lessor and lessee is $20
million. The first payment was made at the inception of the lease.
Required:
How would American Parcel Service classify this lease if it prepares its financial statements
Chapter 15 Leases
using U.S. GAAP? IFRS? Why?
170. Savinsky Industries prepares its financial statements using IFRS and reports its leases as
finance leases. If the company reported under U.S. GAAP, is it possible that some of the
leases could be classified as an operating lease? Explain
Chapter 15 Leases
171. How do U.S. GAAP and International Financial Reporting Standards (IFRS) differ with
respect to the interest rate used to discount minimum lease payments?
172. How do U.S. GAAP and International Financial Reporting Standards (IFRS) differ with
respect to leases of land and buildings?
173. How do U.S. GAAP and International Financial Reporting Standards (IFRS) differ with
respect to classifying a lease as a capital lease?
Chapter 15 Leases
174. The IASB and FASB are collaborating on a joint project intended to revise standards for
accounting for leases. Briefly describe the tentative decisions of the two boards regarding the
overall approach of the new standard.
175. Compare and contrast the way leases are classified between operating and finance (capital)
leases under U.S. GAAP and IFRS.
