Accounting for Leases
21 – 21
78. From the viewpoint of Yates, what type of lease agreement exists?
a. Operating lease
b. Capital lease
c. Sales-type lease
d. Direct-financing lease
79. If Yates records this lease as a direct-financing lease, what amount would be recorded as
Lease Receivable at the inception of the lease?
a. $287,432
b. $786,282
c. $800,000
d. $862,296
80. Which of the following lease-related revenue and expense items would be recorded by
Yates if the lease is accounted for as an operating lease?
a. Rent Revenue only
b. Interest Revenue only
c. Depreciation Expense only
d. Rent Revenue and Depreciation Expense
81. Hook Company leased equipment to Emley Company on July 1, 2014, for a one-year
period expiring June 30, 2015, for $60,000 a month. On July 1, 2015, Hook leased this
piece of equipment to Terry Company for a three-year period expiring June 30, 2018, for
$75,000 a month. The original cost of the equipment was $4,800,000. The equipment,
which has been continually on lease since July 1, 2010, is being depreciated on a straight-
line basis over an eight-year period with no salvage value. Assuming that both the lease
to Emley and the lease to Terry are appropriately recorded as operating leases for
accounting purposes, what is the amount of income (expense) before income taxes that
each would record as a result of the above facts for the year ended December 31, 2015?
Hook Emley Terry
a. $210,000 $(360,000) $(450,000)
b. $210,000 $(360,000) $(750,000)
c. $810,000 $(60,000) $(150,000)
d. $810,000 $(660,000) $(450,000)
Use the following information for questions 82 and 83.
Hull Co. leased equipment to Riggs Company on May 1, 2015. At that time the collectibility of the
minimum lease payments was not reasonably predictable. The lease expires on May 1, 2016.
Riggs could have bought the equipment from Hull for $4,800,000 instead of leasing it. Hull’s
accounting records showed a book value for the equipment on May 1, 2012, of $4,200,000. Hull’s
depreciation on the equipment in 2015 was $540,000. During 2015, Riggs paid $1,080,000 in
rentals to Hull for the 8-month period. Hull incurred maintenance and other related costs under
the terms of the lease of $96,000 in 2015. After the lease with Riggs expires, Hull will lease the
equipment to another company for two years.
82. Ignoring income taxes, the amount of expense incurred by Riggs from this lease for the
year ended December 31, 2015, should be
a. $444,000.
b. $540,000.
c. $984,000.
d. $1,080,000.
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 22
83. The income before income taxes derived by Hull from this lease for the year ended
December 31, 2015, should be
a. $444,000.
b. $540,000.
c. $984,000.
d. $1,080,000.
84. On January 2, 2014, Gold Star Leasing Company leases equipment to Brick Co. with 5
equal annual payments of $80,000 each, payable beginning January 2 31, 2014. Brick Co.
agrees to guarantee the $50,000 residual value of the asset at the end of the lease term.
Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit
interest rate is 8%. What journal entry would Gold Star make at January 2, 2014 assuming
this is a direct–financing lease?
PV Annuity Due PV Ordinary Annuity PV Single Sum
8%, 5 periods 4.31213 3.99271 .68508
10%, 5 periods 4.16986 3.79079 .62092
a. Cash 80,000
Lease Receivable 370,000
Equipment 450,000
b. Cash 80,000
Lease Receivable 264,970
Loss 105,030
Equipment 450,000
c. Cash 80,000
Lease Receivable 284,635
Equipment 364,635
d. Cash 80,000
Lease Receivable 299,224
Equipment 379,224
85. Mays Company has a machine with a cost of $500,000 which also is its fair value on the
date the machine is leased to Park Company. The lease is for 6 years and the machine is
estimated to have an unguaranteed residual value of $50,000. If the lessor’s interest rate
implicit in the lease is 12%, the six beginning-of-the-year lease payments would be
a. $115,451.
b. $103,082.
c. $97,725.
d. $83,333.
Accounting for Leases
21 – 23
86. On January 2, 2014, Gold Star Leasing Company leases equipment to Brick Co. with 5
equal annual payments of $80,000 each, payable beginning January 2, 2014. Brick Co.
agrees to guarantee the $50,000 residual value of the asset at the end of the lease term.
Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit
interest rate is 8%. What journal entry would Brick Co. make at January 2, 2014 to record
the lease?
PV Annuity Due PV Ordinary Annuity PV Single Sum
8%, 5 periods 4.31213 3.99271 .68508
10%, 5 periods 4.16986 3.79079 .62092
a. Lease Equipment 299,224
Lease Liability 299,224
b. Leased Equipment 379,224
Cash 80,000
Lease Liability 299,224
c. Leased Equipment 344,970
Cash 80,000
Lease Liability 264,970
d. Leased Equipment 353,671
Cash 80,000
Lease Liability 273,671
87. On January 2, 2014, Gold Star Leasing Company leases equipment to Brick Co. with 5
equal annual payments of $80,000 each, payable beginning January 2, 2014. Brick Co.
agrees to guarantee the $50,000 residual value of the asset at the end of the lease term.
Brick’s incremental borrowing rate is 10%, however it knows that Gold Star’s implicit
interest rate is 8%. What journal entry would Brick Co. make at January 1, 2015 to record
the second lease payment?
PV Annuity Due PV Ordinary Annuity PV Single Sum
8%, 5 periods 4.31213 3.99271 .68508
10%, 5 periods 4.16986 3.79079 .62092
a. Lease Liability 80,000
Cash 80,000
b. Lease Liability 58,802
Interest Payable 21,198
Cash 80,000
c. Lease Liability 56,062
Interest Payable 23,938
Cash 80,000
d. Lease Liability 58,106
Interest Payable 21,894
Cash 80,000
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 24
88. Geary Co. leased a machine to Dains Co. Assume the lease payments were made on the
basis that the residual value was guaranteed and Geary gets to recognize all the profits.
At the end of the lease term, before the lessee transfers the asset to the lessor, the leased
asset and obligation accounts have the following balances:
Leased equipment $400,000
Less accumulated depreciation—capital lease 384,000
$ 16,000
Interest payable $ 1,520
Lease liability 14,480
$16,000
If, at the end of the lease, the fair value of the residual value is $9,800, what gain or loss
should Geary record?
a. $4,680 gain
b. $8,280 loss
c. $6,200 loss
d. $9,800 gain
89. Harter Company leased machinery to Stine Company on July 1, 2015, for a ten-year
period expiring June 30, 2025. Equal annual payments under the lease are $150,000 and
are due on July 1 of each year. The first payment was made on July 1, 2013. The rate of
interest used by Harter and Stine is 9%. The cash selling price of the machinery is
$1,050,000 and the cost of the machinery on Harter’s accounting records was $930,000.
Assuming that the lease is appropriately recorded as a sale for accounting purposes by
Harter, what amount of interest revenue would Harter record for the year ended
December 31, 2015?
a. $94,500
b. $81,000
c. $40,500
d. $0
90. Pye Company leased equipment to the Polan Company on July 1, 2015, for a ten-year
period expiring June 30, 2025. Equal annual payments under the lease are $160,000 and
are due on July 1 of each year. The first payment was made on July 1, 2015. The rate of
interest contemplated by Pye and Polan is 9%. The cash selling price of the equipment is
$1,120,000 and the cost of the equipment on Pye’s accounting records was $992,000.
Assuming that the lease is appropriately recorded as a sale for accounting purposes by
Pye, what is the amount of profit on the sale and the interest revenue that Pye would
record for the year ended December 31, 2015?
a. $128,000 and $100,800
b. $128,000 and $86,400
c. $128,000 and $43,200
d. $0 and $0
Use the following information for questions 91 and 92.
Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc., on
July 1, 2015. The lease is appropriately accounted for as a sales-type lease by Metro and as a
capital lease by Sands. The lease is for a 10-year period (the useful life of the asset) expiring
June 30, 2025. The first of 10 equal annual payments of $552,000 was made on July 1, 2015.
Metro had purchased the equipment for $3,500,000 on January 1, 2015, and established a list
selling price of $4,800,000 on the equipment. Assume that the present value at July 1, 2015, of
the rent payments over the lease term discounted at 8% (the appropriate interest rate) was
$4,000,000.
Accounting for Leases
21 – 25
91. Assuming that Sands, Inc. uses straight-line depreciation, what is the amount of deprecia–
tion and interest expense that Sands should record for the year ended December 31,
2015?
a. $200,000 and $137,920
b. $200,000 and $160,000
c. $2,400,000 and $137,920
d. $2,400,000 and $160,000
92. What is the amount of profit on the sale and the amount of interest revenue that Metro
should record for the year ended December 31, 2015?
a. $0 and $137,920
b. $500,000 and $137,920
c. $500,000 and $160,000
d. $800,000 and $320,000
93. Roman Company leased equipment from Koenig Company on July 1, 2015, for an eight-
year period expiring June 30, 2023. Equal annual payments under the lease are $600,000
and are due on July 1 of each year. The first payment was made on July 1, 2015. The rate
of interest contemplated by Roman and Koenig is 8%. The cash selling price of the
equipment is $3,723,750 and the cost of the equipment on Koenig’s accounting records
was $3,300,000. Assuming that the lease is appropriately recorded as a sale for
accounting purposes by Koenig, what is the amount of profit on the sale and the interest
income that Koenig would record for the year ended December 31, 2015?
a. $0 and $0
b. $0 and $124,950
c. $423,750 and $124,950
d. $423,750 and $148,950
Use the following information for questions 94 through 98.
Gage Co. purchases land and constructs a service station and car wash for a total of $360,000.
At January 2, 2014, when construction is completed, the facility and land on which it was
constructed are sold to a major oil company for $400,000 and immediately leased from the oil
company by Gage. Fair value of the land at time of the sale was $40,000. The lease is a 10-year,
noncancelable lease. Gage uses straight-line depreciation for its other various business holdings.
The economic life of the facility is 15 years with zero salvage value. Title to the facility and land
will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as
follows:
Payments Interest Amortization Balance
Jan. 2, 2014 $400,000.00
Dec. 31, 2014 $65,098.13 $40,000.00 $25,098.13 374,901.87
Dec. 31, 2015 65,098.13 37,490.19 27,607.94 347,293.93
Dec. 31, 2016 65,098.13 34,729.39 30,368.74 316,925.19
94. From the viewpoint of the lessor, what type of lease is involved above?
a. Sales-type lease
b. Sale-leaseback
c. Direct-financing lease
d. Operating lease
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 26
95. What is the discount rate implicit in the amortization schedule presented above?
a. 12%
b. 10%
c. 8%
d. 6%
96. The total lease-related expenses recognized by the lessee during 2015 is which of the
following? (Rounded to the nearest dollar.)
a. $64,000
b. $65,098
c. $73,490
d. $61,490
97. What is the amount of the lessee’s liability to the lessor after the December 31, 2016
payment? (Rounded to the nearest dollar.)
a. $400,000
b. $374,902
c. $347,294
d. $316,925
*98. The total lease-related income recognized by the lessee during 2015 is which of the
following?
a. $ -0-
b. $2,667
c. $4,000
d. $40,000
*99. On June 30, 2015, Falk Co. sold equipment to an unaffiliated company for $1,000,000.
The equipment had a book value of $900,000 and a remaining useful life of 10 years. That
same day, Falk leased back the equipment at $10,000 per month for 5 years with no
option to renew the lease or repurchase the equipment. Falk’s rent expense for this
equipment for the year ended December 31, 2015, should be
a. $240,000.
b. $60,000.
c. $100,000.
d. $80,000.
Accounting for Leases
21 – 27
Future Value of Ordinary Annuity of 1
Period 5% 6% 8% 10% 12%
1 1.00000 1.00000 1.00000 1.00000 1.00000
2 2.05000 2.06000 2.08000 2.10000 2.12000
3 3.15250 3.18360 3.24640 3.31000 3.37440
4 4.31013 4.37462 4.50611 4.64100 4.77933
5 5.52563 5.63709 5.86660 6.10510 6.35285
6 6.80191 6.97532 7.33592 7.71561 8.11519
7 8.14201 8.39384 8.92280 9.48717 10.08901
8 9.54911 9.89747 10.63663 11.43589 12.29969
9 11.02656 11.49132 12.48756 13.57948 14.77566
10 12.57789 13.18079 14.48656 15.93743 17.54874
Present Value of an Ordinary Annuity of 1
Period 5% 6% 8% 10% 12%
1 .95238 .94340 .92593 .90909 .89286
2 1.85941 1.83339 1.78326 1.73554 1.69005
3 2.72325 2.67301 2.57710 2.48685 2.40183
4 3.54595 3.46511 3.31213 3.16986 3.03735
5 4.32948 4.21236 3.99271 3.79079 3.60478
6 5.07569 4.91732 4.62288 4.35526 4.11141
7 5.78637 5.58238 5.20637 4.86842 4.56376
8 6.46321 6.20979 5.74664 5.33493 4.96764
9 7.10782 6.80169 6.24689 5.75902 5.32825
10 7.72173 7.36009 6.71008 6.14457 5.65022
MULTIPLE CHOICE—CPA Adapted
100. Lease A does not contain a bargain purchase option, but the lease term is equal to 90
percent of the estimated economic life of the leased property. Lease B does not transfer
ownership of the property to the lessee by the end of the lease term, but the lease term is
equal to 75 percent of the estimated economic life of the leased property. How should the
lessee classify these leases?
Lease A Lease B
a. Operating lease Capital lease
b. Operating lease Operating lease
c. Capital lease Capital lease
d. Capital lease Operating lease
101. On December 31, 2015, Burton, Inc. leased machinery with a fair value of $1,260,000
from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual
payments of $240,000 beginning December 31, 2015. The lease is appropriately
accounted for by Burton as a capital lease. Burton’s incremental borrowing rate is 11%.
Burton 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.
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 28
In its December 31, 2015 balance sheet, Burton should report a lease liability of
a. $909,792.
b. $1,020,000.
c. $1,127,016.
d. $1,149,792.
102. On December 31, 2014, Harris Co. leased a machine from Catt, Inc. for a five-year period.
Equal annual payments under the lease are $1,050,000 (including $50,000 annual
executory costs) and are due on December 31 of each year. The first payment was made
on December 31, 2014, and the second payment was made on December 31, 2015. The
five lease payments are discounted at 10% over the lease term. The present value of
minimum lease payments at the inception of the lease and before the first annual payment
was $4,170,000. The lease is appropriately accounted for as a capital lease by Harris. In
its December 31, 2015 balance sheet, Harris should report a lease liability of
a. $3,170,000.
b. $3,120,000.
c. $2,853,000.
d. $2,487,000.
103. A lessee had a ten-year capital 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 liability in year 1.
d. one-tenth of the original lease liability.
Use the following information for questions 104 and 105.
On January 2, 2015, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill
press. The lease stipulated annual payments of $200,000 starting at the beginning of the first
year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this
transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no
salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate
lease payments were determined to have a present value of $1,200,000, based on implicit
interest of 10%.
104. In its 2015 income statement, what amount of interest expense should Hernandez report
from this lease transaction?
a. $0
b. $81,000
c. $108,000
d. $120,000
105. In its 2015 income statement, what amount of depreciation expense should Hernandez
report from this lease transaction?
a. $200,000
b. $160,000
c. $120,000
d. $80,000
Accounting for Leases
21 – 29
106. In a lease that is recorded as a sales-type lease by the lessor, interest revenue
a. should be recognized in full as revenue at the lease’s inception.
b. should be recognized over the period of the lease using the straight-line method.
c. should be recognized over the period of the lease using the effective interest method.
d. does not arise.
107. Torrey Co. manufactures equipment that is sold or leased. On December 31, 2015, Torrey
leased equipment to Dalton for a five-year period ending December 31, 2020, at which
date ownership of the leased asset will be transferred to Dalton. Equal payments under
the lease are $550,000 (including $50,000 executory costs) and are due on December 31
of each year. The first payment was made on December 31, 2015. Collectibility of the
remaining lease payments is reasonably assured, and Torrey has no material cost
uncertainties. The normal sales price of the equipment is $1,925,000, and cost is
$1,500,000. For the year ended December 31, 2015, what amount of income should
Torrey realize from the lease transaction?
a. $425,000
b. $550,000
c. $575,000
d. $825,000
*108. Jamar Co. sold its headquarters building at a gain, and simultaneously leased back the
building. The lease was reported as a capital lease. At the time of the sale, the gain
should be reported as
a. operating income.
b. an extraordinary item, net of income tax.
c. a separate component of stockholders’ equity.
d. a deferred gain.
*109. On December 31, 2015, Haden Corp. sold a machine to Ryan and simultaneously leased
it back for one year. Pertinent information at this date follows:
Sales price $900,000
Carrying amount 825,000
Present value of reasonable lease rentals
($7,500 for 12 months @ 12%) 85,000
Estimated remaining useful life 12 years
In Haden’s December 31, 2015 balance sheet, the deferred profit from the sale of this
machine should be
a. $85,000.
b. $75,000.
c. $10,000.
d. $0.
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 30
DERIVATIONS — Computational
No. Answer Derivation
Accounting for Leases
21 – 31
DERIVATIONS — Computational (cont.)
No. Answer Derivation
Test Bank for Intermediate Accounting, Fifteenth Edition
21 – 32
DERIVATIONS — Computational (cont.)
No. Answer Derivation
DERIVATIONS — CPA Adapted
No. Answer Derivation
Accounting for Leases
21 – 33
DERIVATIONS — CPA Adapted (cont.)
No. Answer Derivation
BRIEF EXERCISES
BE. 21-110—Capital lease (Essay).
Explain the procedures used by the lessee to account for a capital lease.
Solution 21-110
BE. 21-111—Capital lease amortization and journal entries.
Hughey Co. as lessee records a capital lease of machinery on January 1, 2014. The seven
annual lease payments of $700,000 are made at the end of each year. The present value of the
lease payments at 10% is $3,408,000. Hughey uses the effective-interest method of amortization
and sum-of-the-years’-digits depreciation (no residual value).
Instructions (Round to the nearest dollar.)
(a) Prepare an amortization table for 2014 and 2015.
(b) Prepare all of Hughey’s journal entries for 2014.
Solution 21-111