Chapter 15 Leases
True/False Questions
1. At the inception of a lease agreement, the company’s debt to equity ratio and rate of return on
assets are both affected whether the lease is classified as a capital lease or as an operating
lease.
2. Capital leases are agreements that are formulated outwardly as leases, but are installment
purchases in substance.
3. The criterion of 75% of economic life for classifying a lease as a capital lease is consistent
with the basic premise that most of the risks and rewards of ownership occur during the first
75% of an asset’s life.
4. In accounting for operating leases, the lessor, rather than the lessee, will recognize
depreciation on the leased asset.
5. In addition to the criteria that must be met by the lessee, the lessor must meet additional
conditions for classification as a capital lease to satisfy revenue recognition criteria.
6. When accounting for a capital lease, the lessee records the leased asset at the present value of
the minimum lease payments or the asset’s fair value, whichever is lower.
7. A bargain purchase option is defined as the option of purchasing leased property at a price that
is equal to the expected fair value of a leased asset.
8. When the lessee guarantees an estimated residual value of $75,000, the amount the lessee
records as a leased asset and lease liability is increased by $75,000.
9. If the lessee is expected to take ownership of a leased asset at the end of the lease term, the
lessor must use an estimated residual value when calculating the lease payments necessary to
achieve a desired rate of return.
10. On a sale-leaseback transaction, any gain on the “sale” portion of the transaction is recognized
immediately.
Chapter 15 Leases
Multiple Choice Questions
11. GAAP requires that some lease agreements be accounted for as purchases. The theoretical
justification for this treatment is that a lease of this type:
a. Complies with the concept of form over substance.
b. Reflects the relationship of cause and effect.
c. Satisfies the concept of historical cost.
d. Conveys most of the risks and benefits of property ownership.
12. From the perspective of the lessee, leases may be classified as either:
a. Direct financing or sales-type.
b. Capital or direct financing.
c. Capital or operating.
d. Direct financing or operating.
13. From the perspective of the lessor, leases may be classified as either:
a. Direct financing or sales-type.
b. Operating, capital, or direct financing.
c. Operating, sales-type, indirect financing.
d. Operating, direct financing, or sales-type.
14. Distinguishing between operating and capital leases is due in large part to the accounting
concept of:
a. Conservatism.
b. Materiality.
c. Substance over form.
Chapter 15 Leases
d. Historical cost.
15. When the total expenses over the life of an operating lease are compared to the total expenses
over the life of a capital lease, one will find that:
a. The expenses of a capital lease are greater than the expenses of the operating lease.
b. The expenses of the capital lease and operating lease are equal.
c. The expenses of an operating lease are greater than the expenses of a capital lease.
d. No meaningful comparison can be made.
16. The four criteria provided in GAAP for distinguishing a capital lease from an operating lease
do not include:
a. The agreement specifies that ownership transfers at the end of the lease term.
b. The collectibility of the lease payments must be reasonably predictable.
c. The agreement contains a bargain purchase option.
d. The noncancelable lease term is 75% or more of the useful life of the leased asset.
17. Of the four criteria for a capital lease, the one that most often is the decisive criteria is:
a. The 75% of economic life test.
b. The transfer of title.
c. The 90% of fair value test.
d. The bargain purchase option.
18. One of the four criteria for a capital lease specifies that the lease term be equal to or greater
than:
a. 75% of the expected economic life of the leased property.
b. 90% of the expected economic life of the leased property.
c. 80% of the expected economic life of the leased property.
d. 50% of the expected economic life of the leased property.
19. One of the four criteria for a capital lease specifies that the present value of the minimum lease
payments be equal to or greater than:
a. 90% of the cost of the asset.
b. 75% of the fair value of the asset.
c. 90% of the fair value of the asset.
d. 75% of the cost of the asset.
20. For the lessee to account for a lease as a capital lease, the lease must meet:
a. All four of the criteria specified by GAAP regarding accounting for leases.
b. Any one of the six criteria specified by GAAP regarding accounting for leases.
c. Any two of the criteria specified by GAAP regarding accounting for leases.
d. Any one of the four criteria specified by GAAP regarding accounting for leases.
21. For the lessor to account for a lease as a capital lease, the lease must meet:
Chapter 15 Leases
a. Any one of first four classification criteria and both of the last two additional conditions
specified by GAAP regarding accounting for leases.
b. Any one of the six criteria specified by GAAP regarding accounting for leases.
c. All four of the criteria specified by GAAP regarding accounting for leases.
d. Any one of the four criteria specified by GAAP regarding accounting for leases.
22. Which of the following is not among the criteria for classifying a lease as a capital lease?
a. The agreement specifies that ownership of the asset transfers to the lessee.
b. The agreement contains a bargain purchase option.
c. The noncancelable lease term is equal to 90% or more of the expected economic life of
the asset.
d. The present value of the minimum lease payments is equal to or greater than 90% of the
fair value of the asset.
23. Of the four criteria for a capital lease, which two are not applied if the lease begins during the
final quarter of the asset’s useful life?
a. The 75% test and the bargain purchase option.
b. The 90% test and the 75% test.
c. The 90% test is the only one to which this applies.
d. The bargain purchase and the passage of title criteria.
24. On February 1, 2016, Pearson Corporation became the lessee of equipment under a five-year,
noncancelable lease. The estimated economic life of the equipment is eight years. The fair
value of the equipment was $600,000. The lease does not meet the definition of a capital lease
in terms of a bargain purchase option, transfer of title, or the lease term. However, Pearson
must classify this as a capital lease if the present value of the minimum lease payments is at
Chapter 15 Leases
least
a. $600,000.
b. $540,000.
c. $450,000.
d. $405,000.
Use the following to answer questions 25–28:
Technoid Inc. sells computer systems. Technoid leases computers to Lone Star Company on January
1, 2016. The manufacturing cost of the computers was $12 million.
This noncancelable lease had the following terms:
• Lease payments: $2,466,754 semiannually; first payment at January 1, 2016; remaining payments
at June 30 and December 31 each year through June 30, 2020.
• Lease term: five years (10 semiannual payments).
• No residual value; no bargain purchase option.
• Economic life of equipment: five years.
• Implicit interest rate and lessee’s incremental borrowing rate: 5% semiannually.
• Fair value of the computers at January 1, 2016: $20 million.
Collectibility of the rental payments is reasonably assured, and there are no lessor costs yet to be
incurred.
25. Technoid would account for this as:
a. A capital lease.
b. A direct financing lease.
c. A sales-type lease.
d. An operating lease.
26. Lone Star Company would account for this as:
a. A capital lease.
b. A direct financing lease.
c. A sales type lease.
Chapter 15 Leases
d. An operating lease.
27. What is the net book value of the lease liability in Lone Star’s June 30, 2016, balance sheet?
Round your answer to the nearest dollar.
a. $15,943,154.
b. $17,533,246.
c. $21,000,000.
d. None of these answer choices is correct.
28. What is the interest revenue that Technoid would report on this lease in its 2016 income
statement?
a. $0.
b. $1,673,820.
c. $876,662.
d. None of these answer choices is correct.
Chapter 15 Leases
Use the following to answer questions 29–33:
On December 31, 2015, Reagan Inc. signed a lease for some equipment having a nine-year useful life
with Silver Leasing Co. The lease payments are made by Reagan annually, beginning at signing date.
Title does not transfer to the lessee, so the equipment will be returned to the lessor on December 31,
2021. There is no bargain purchase option, and Reagan guarantees a residual value to the lessor on
termination of the lease.
Reagan’s lease amortization schedule appears below:
Payments
Interest
Balance
$519,115
$90,000
429,115
$90,000
$17,165
356,280
$90,000
14,251
280,531
$90,000
11,221
201,752
$90,000
8,070
119,822
$90,000
4,793
34,615
$36,000
1,385
0
29. In this situation, Reagan:
a. is the lessee in a sales-type lease.
b. is the lessee in a capital lease.
c. is the lessor in a capital lease.
d. is the lessor in a sales-type lease.
30. What is the book value of the lease liability on Reagan’s December 31, 2017, balance sheet
(after the third lease payment is made)?
a. $280,531.
b. $190,530.
c. $266,280.
d. $356,280.
Chapter 15 Leases
31. At what amount would Reagan record the leased asset at inception of the agreement?
a. $519,115.
b. $429,115.
c. $540,000.
d. $576,000.
32. What is the effective annual interest rate charged to Reagan on this lease?
a. 4%.
b. 6%.
c. 8%.
d. 17%.
33. What is the amount of residual value guaranteed by Reagan to the lessor?
a. $ 1,385.
b. $34,615.
c. $36,000.
d. Cannot be determined from the given information.
34. The appropriate asset value reported in the balance sheet by the lessee for an operating lease
is:
a. Present value of the minimum lease payments.
b. Sum of the minimum lease payments.
c. Fair value of the asset at the inception of the lease.
d. Zero, unless a prepayment or accrual is involved.
35. Which of the following statements characterizes an operating lease?
a. The lessee records depreciation and interest.
b. The lessor records depreciation and lease revenue.
c. The lessor transfers title at the end of the lease term.
d. The lessee records a leased asset.
36. Crystal Corporation recorded a lease payment as follows:
Rent expense
2,000
Cash
2,000
Crystal must have a(n):
a. Operating lease.
b. Leveraged lease.
c. Capital lease.
d. Direct financing lease.
Chapter 15 Leases
37. If the lessor records deferred rent revenue at the beginning of a lease term, the lease must:
a. Be a direct financing lease.
b. Be a sales-type lease.
c. Contain a bargain renewal option.
d. Be an operating lease.
38. Prepayments made by the lessee on an operating lease are considered to be:
a. A lease expense.
b. A depreciable asset.
c. Deferred revenue.
d. A prepayment of rent expense.
39. On January 1, 2016, Gibson Corporation entered into a four-year operating lease. The
payments were as follows: $20,000 for 2016, $18,000 for 2017, $16,000 for 2018, and
$14,000 for 2019. What is the correct amount of lease expense for 2017?
a. $20,500.
b. $19,000.
c. $17,000.
d. $18,000.
40. On January 1, 2016, Wellburn Corporation leased an asset from Tabitha Company. The asset
originally cost Tabitha $300,000. The lease agreement is an operating lease that calls for four
annual payments beginning on January 1, 2016, in the amount of $36,000. The other three
remaining payments will be made on January 1 of each subsequent year. Which of the
following journal entries should Tabitha record on January 1, 2016?
a.
Cash
36,000
Lease receivable
36,000
b.
Cash
36,000
Deferred rent revenue
36,000
c.
Cash
36,000
Rent revenue
36,000
d.
Cash
36,000
Rent expense
36,000
41. On September 1, 2016, Custom Shirts Inc. entered into a lease agreement appropriately
classified as an operating lease. The lease term is three years. The annual payments are (a)
$20,000 for year 1, (b) $24,000 for year 2, and (c) $28,000 for year 3. How much rent expense
will Custom Shirts recognize for 2016?
a. $ 6,667.
b. $24,000.
c. $20,000.
d. $ 8,000.
Year 1
$72,000/3 x 4/12 = $8,000
Year 2
Year 3
Total
42. The lessee normally measures the lease liability to be recorded as the:
a. Future value of the minimum lease payments.
b. Sum of the cash payments over the term of the lease.
$68,000/4 = $17,000
Chapter 15 Leases
c. Present value of the minimum lease payments.
d. Fair market value of the leased asset.
43. Leasehold improvements usually are classified in a balance sheet as:
a. Property, plant, and equipment.
b. Other long-term assets.
c. Investments.
d. Expenses.
Use the following to answer questions 44–48:
Refer to the following lease amortization schedule. The 10 payments are made annually starting with
the inception of the lease. Title does not transfer to the lessee and there is no bargain purchase option
or guaranteed residual value. The asset has an expected economic life of 12 years. The lease is
noncancelable.
Cash
Effective
Decrease
Payment
Payment
Interest
in balance
Balance
63,282
1
10,000
10,000
53,282
2
10,000
6,394
3,606
49,676
3
10,000
5,961
4,039
45,638
4
10,000
5,477
4,523
41,114
5
10,000
4,934
5,066
36,048
6
10,000
4,326
5,674
30,373
7
10,000
3,645
6,355
24,018
8
10,000
2,882
7,118
16,901
9
10,000
?
?
?
10
10,000
?
?
?
44. What is the effective annual interest rate?
a. 9%.
b. 10%.
c. 11%.
d. 12%.
Chapter 15 Leases
45. What would the lessee record as annual depreciation on the asset using the straight-line
method?
a. $ 5,328.
b. $ 6,328.
c. $ 6,392.
d. $10,000.
46. What would be the outstanding balance after payment 10?
a. $0.
b. $ 2,028.
c. $ 8,929.
d. $10,000.
47. What is the total effective interest paid over the term of the lease?
a. $100,000.
b. $ 36,718.
c. $ 53,282.
d. $ 63,282.
48. What is the outstanding balance after payment 9?
a. $ 8,929.
b. $13,463.
c. $ 5,000.
d. $ 5,537.
49. When a lease qualifies as a capital lease, what is the cost basis of the asset acquired?
a. The present value of the minimum lease payments, exclusive of executory costs.
b. The present value of the minimum lease payments plus executory costs.
c. The sum of the gross minimum lease payments.
d. The present value of the minimum lease payments plus the present value of executory
costs.
50. For a capital lease, an amount equal to the present value of the minimum lease payments
should be recorded by the lessee as a(n):
a. Asset and a liability.
b. Asset and a different amount should be recorded as a liability.
c. Liability and a different amount should be recorded as an asset.
d. Expense.
51. Like other assets, the cost of a leasehold improvement is allocated as depreciation expense
over its useful life to the lessee, which will be:
a. The shorter of the physical life of the asset or the lease term.
b. The physical life of the asset.
c. The lease term.
d. A time period determined by management.
52. A direct financing lease is classified in the lessor’s balance sheet as:
a. An asset.
b. A liability.
c. Interest revenue.
d. A contra account to lease liability.
53. For a leased asset under a lease that qualifies as a capital lease because of a bargain purchase
option, the depreciation period used by the lessee must be:
a. The same period that was used by the lessor.
b. The useful life to the lessee.
c. The term of the lease regardless of the lease provisions.
d. The remaining life of the asset at the time the lease agreement took effect.
54. If the lessor retains title to leased property under the terms of the lease:
a. The amount to be recovered through periodic lease payments is reduced by the present
value of the residual amount.
b. The amount to be recovered through periodic lease payments is increased by the present
value of the residual amount.
c. The amount to be recovered will be the same as if there were no residual value.
d. The lessor will record a greater amount of depreciation due to the residual value.
Use the following to answer questions 55–59:
Refer to the following lease amortization schedule. The five payments are made annually starting with
the inception of the lease. A $2,000 bargain purchase option is exercisable at the end of the five-year
lease. The asset has an expected economic life of eight years.
Lease
Cash
Effective
Decrease in
Payment
Payment
Interest
Balance
Balance
34,600
1
8,000
??
??
26,600
2
8,000
2,660
5,340
21,260
3
8,000
2,126
5,874
15,386
4
8,000
1,539
6,461
8,925
5
8,000
??
??
??
6
2,000
182
1,818
0
55. What is the effective annual interest rate?
a. 9%.
b. 10%.
c. 11%.
d. 20%.
56. What would the lessee record as annual depreciation on the asset using the straight-line
method, assuming no residual value?
a. $3,325.
Chapter 15 Leases
b. $6,920.
c. $4,325.
d. $5,320.
57. What is the total interest paid over the term of the lease?
a. $42,000.
b. $ 8,200.
c. $ 7,400.
d. $ 3,460.
58. What is the outstanding balance after payment 5?
a. $1,818.
b. $2,000.
c. $2,182.
d. $3,818.