CHAPTER 21
ACCOUNTING FOR LEASES
CHAPTER LEARNING OBJECTIVES
1. Understand the environment related to leasing transactions.
2. Explain the accounting for leases by lessees.
3. Explain the accounting for leases by lessors.
4. Discuss the accounting and reporting for special features of lease arrangements.
*5. Describe the lessee’s accounting for sale-leaseback transactions.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 2
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY
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TRUE-FALSE STATEMENTS
1.
1
K
5.
2
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9.
2
K
13.
4
K
17.
6
K
2.
1
K
6.
3
K
10.
6
K
14.
4
K
18.
4
K
3.
2
K
7.
1
K
11.
3
K
15.
4
K
19.
4
K
4.
4
C
8.
3
K
12.
4
K
16.
4
K
20.
5
K
MULTIPLE CHOICE QUESTIONS
21.
1
K
39.
3
K
57.
2
K
75.
2
C
93.
2
AP
22.
1
K
40.
2
K
58.
4
AP
76.
3
C
94.
5
C
23.
1
K
41.
4
K
59.
2
K
77.
2
AP
95.
5
AP
24.
1
C
42.
4
K
60.
2
AP
78.
3
C
96.
2
AP
25.
1
K
43.
6
C
61.
2
AP
79.
6
AP
97.
2
AP
26.
2
C
44.
4
C
62.
2
AP
80.
3
C
98.
5
AP
27.
2
K
45.
4
K
63.
2
AP
81.
3
AP
99.
5
AP
28.
2
K
46.
4
C
64.
2
AP
82.
1
AP
100.
2
C
29.
2
K
47.
4
K
65.
2
AP
83.
3
AP
101.
2
AP
30.
1
K
48.
4
C
66.
2
AP
84.
4
AP
102.
4
AP
31.
2
K
49.
5
C
67.
2
AP
85.
4
AP
103.
2
C
32.
1
K
50.
5
K
68.
2
AP
86.
4
AP
104.
2
AP
33.
1
K
51.
5
K
69.
2
AP
87.
4
AP
105.
2
AP
34.
2
K
52.
2
AP
70.
2
AP
88.
4
AP
106.
4
C
35.
4
K
53.
2
AP
71.
2
AP
89.
2
AP
107.
4
AP
36.
3
C
54.
2
AP
72.
2
AP
90.
2
AP
108.
5
C
37.
4
K
55.
2
AP
73.
2
AP
91.
2
AP
109.
3
AP
38.
2
K
56.
2
C
74.
2
AP
92.
2
AP
BRIEF EXERCISES
110.
2
C
111.
2
AP
112.
3
AP
EXERCISES
113.
1-3
K
114.
2
C
115.
2
AP
116.
5
AP
117.
5
AP
PROBLEMS
118.
2
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119.
2, 4
AP
120.
6
AP
Accounting for Leases
21 – 3
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 IASB 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 only reports interest expense on its income statement in a finance lease.
7. A benefit of leasing to the lessor is the return of the leased property at the end of the lease
term.
8. In a finance lease, the lessee reports interest expense but not amortization expense on
the income statement.
9. If a lease does not transfer control of the asset over the lease term, the lessor will
generally account for the lease as a sales-type lease.
10. Direct-financing leases involve a third party in addition to the lessee.
11. Under an operating lease, the lessor records each lease receipt as part interest revenue
and part lease 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. If it is probable that the expected residual value is less than the guaranteed residual value,
the difference should be included in the computation of the lease liability.
14. Both a guaranteed and an unguaranteed residual value affect the lessee’s computation of
amounts capitalized as a leased asset.
15. When a lease has an unguaranteed residual value, the lessor reduces sales revenue and
cost of goods sold by the present value of the unguaranteed residual value.
16. If a lease includes a bargain purchase option, the lessee must increase the present value
of the lease payments by the purchase option price.
17. The basic difference between a direct-financing lease and a sales-type lease relates to
the recognition of the profit on the sale.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 4
18. The gross profit amount in a sales-type lease is greater when a guaranteed residual value
exists.
19. For operating leases, a lessor defers the initial direct costs and amortizes them as
expenses over the term of the lease.
20. In a sale-leaseback arrangement the seller-lessee transfers an asset to the buyer-lessor
and then leases the asset back from the buyer-lessor.
True-False Answers—Conceptual
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Accounting for Leases
21 – 5
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. All long-term leases are capitalized.
c. Leases similar to installment purchases 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.
25. A single lease expense is recognized on the income statement for
a. an operating lease.
b. a finance lease.
c. both a finance lease and an operating lease.
d. neither a finance lease or an operating lease.
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 option price.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 6
P27. The amount to be recorded as the cost of an asset under finance lease is equal to the
a. present value of the lease payments.
b. present value of the lease payments or the fair value of the asset, whichever is lower.
c. present value of the lease payments plus the present value of any unguaranteed
residual value.
d. carrying value of the asset on the lessor’s books.
28. The classifications of a lease by the lessee are
a. operating and finance leases.
b. operating, sales, and finance leases.
c. operating and leveraged leases.
d. None of these answers are correct.
29. Which of the following is a correct statement of one of the classification tests?
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 lease payments (excluding executory costs) equal or exceed 90% of the fair value
of the leased property.
30. Lease payments include:
I. fixed payments.
II. variable payments based on an index.
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, II, III, and IV.
31. In computing depreciation of a leased asset where there is no bargain purchase option,
the lessee should subtract
a. no 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 lease payments, the lessee should
a. use its incremental borrowing rate in all cases.
b. use both its incremental borrowing rate and the implicit rate of the lessor, assuming
that the implicit rate is known to the lessee.
c. use the implicit rate of the lessor, assuming that the implicit rate is known to the
lessee.
d. use the implicit rate in all cases.
33. Which of the following is not one of the lease classification tests?
a. Transfer of ownership
b. Purchase option
c. Lease term
d. Collectibility
Accounting for Leases
21 – 7
34. The IASB provides an exception for the required capitalization of all leases by the lessee
for
a. leases of underlying assets with low value only.
b. short-term leases with a term of 12 months or less only.
c. leases of underlying assets with low value and short-term leases with a term of 12
months or less.
d. None of these are correct.
P35. A lessee with a finance 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. Which of the following describes the lease term test?
a. If the lease term is 75% or more of the economic life, it is a finance lease.
b. If the lease term is 90% or more of the economic life, it is a finance lease.
c. If there is a bargain purchase option during the lease term, it is a finance lease.
d. If the asset has an alternative use during the lease term, it is a finance lease.
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. Rental payments.
a. I and III only.
b. II, III, and IV.
c. I and II only.
d. I, II, and IV.
38. The lease receivable amount includes the present value of
a. rental payments plus the present value of guaranteed and unguaranteed residual
values.
b. rental payments only.
c. rental payments plus the present value of the unguaranteed residual value only.
d. rental payments plus the present value of the guaranteed residual value only.
39. In an operating lease, the lessor records
a. depreciation expense only.
b. lease revenue only.
c. lease expense only.
d. depreciation expense and lease revenue.
40. In a finance lease, the lessee records
a. depreciation expense only.
b. interest expense only.
c. lease expense only.
d. depreciation expense and interest expense.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 8
41. When lessors account for residual values related to leased assets, they
a. include the residual value in the receivable measurement 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.
c. are expensed in the period of the sale under a sales-type lease.
d. include lessor advertising costs.
S43. The basic 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 profit on the sale.
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 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 sales price less the present value of the residual value.
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. The right-of-use asset is increased by
a. initial direct costs incurred by the lessee only.
b. lease incentives received.
c. prepaid lease payments only.
d. lease prepayments made by the lessee and initial direct costs incurred by the lessee.
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.
Accounting for Leases
21 – 9
48. Additional lease adjustments that affect the measurement of lease assets and liabilities
include each of the following except?
a. executory costs.
b. initial direct costs.
c. internal costs.
d. lease prepayments and incentives.
*49. If the lease in a sale-leaseback transaction meets one of the five lease tests and is
therefore accounted for as a finance 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 five lease tests are satisfied in a sale-leaseback transaction, which of the
following statements is incorrect?
a. The seller-lessee continues to depreciate the asset.
b. The purchaser-lessor records a gain.
c. The seller-lessee records the lease as an operating lease.
d. The seller-lessee recognizes a gain or loss as appropriate.
*51. When a company sells property and then leases it back, any gain on the sale should
usually be
a. deferred and recognized as income over the term of the lease.
b. recognized as a prior period adjustment.
c. recognized at the end of the lease.
d. recognized in the current year.
Multiple Choice Answers—Conceptual
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Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 10
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 finance 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 €220,000.
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 using 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.
Accounting for Leases
21 – 11
54. What is the annual lease payment excluding executory costs? (Rounded to the nearest
dollar.)
a. €272,703
b. €872,703
c. €887,703
d. €902,703
55. What is 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 in this?
a. Sales-type lease
b. Sale-leaseback
c. Finance 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 asset in 2018 of (Rounded to the
nearest dollar.)
a. €0.
b. €495,000.
c. €610,139.
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. Finance lease
60. Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets
the criteria to be a finance 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.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 12
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 finance 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 liability for finance leases on its December 31, 2019 statement of financial position
is
a. €2,727,635.
b. €2,500,397.
c. €2,177,634.
d. €3,000,000.
Accounting for Leases
21 – 13
62. 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 finance lease. The minimum lease payments were determined to have a
present value of €833,972 at an effective interest rate of 10%.
In 2018, Sauder should record interest expense of
a. €63,397.
b. €116,604.
c. €83,396.
d. €136,604.
63. 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 finance lease. The minimum lease payments were determined to have a
present value of €833,972 at an effective interest rate of 10%.
. 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 finance 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 statement of financial position is
a. £2,640,792.
b. £2,454,870.
c. £2,376,714.
d. £2,190,792.
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 14
65. 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 finance lease. The minimum
lease payments were determined to have a present value of €750,578 at an effective
interest rate of 10%.
With respect to this 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.
66. 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 finance lease. The minimum
lease payments were determined to have a present value of €750,578 at an effective
interest rate of 10%.
With respect to this lease, for 2019 Ogleby should record
a. interest expense of €57,058.
b. interest expense of €75,058.
c. interest expense of €44,764.
d. interest expense of €62,764.
67. Emporia Corporation is a lessee with a finance 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
Accounting for Leases
21 – 15
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 finance 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 finance lease, what is the amount of Lease Liability reduction
recorded in first year after the lease inception.
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
71. 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%. Pisa, Inc. uses the
straight-line method to amortize similar assets. What is the amount of depreciation
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 because the asset is amortized by Tower Company.
b. €284,968
c. €307,767
d. €300,000
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 16
72. Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it
leased equipment with a cost of £480,000 to Silver Point Co. The 5-year lease calls for a
10% down payment and equal annual payments at the end of each year. The equipment
has an expected useful life of 5 years. Silver Point’s incremental borrowing rate is 10%,
and it depreciates similar equipment using the double-declining balance method. The
selling price of the equipment is £780,000, and the rate implicit in the lease is 8%, which is
known to Silver Point Co. What is the amount of interest expense recorded by Silver Point
Co. for the year ended December 31, 2018?
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. £70,200
b. £56,160
c. £62,400
d. £78,000
73. Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it
leased equipment with a cost of £480,000 to Silver Point Co. The 5-year
lease calls for a 10% down payment and equal annual payments of £175,820 at the end
of each year. The equipment has an expected useful life of 5 years. Silver Point’s
incremental borrowing rate is 10%, and it depreciates similar equipment using the double–
declining balance method. The selling price of the equipment is £780,000, and the rate
implicit in the lease is 8%, which is known to Silver Point Co. What is the book value of the
leased asset at December 31, 2018?
a. £780,000
b. £624,000
c. £468,000
d. £499,200
74. Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it
leased equipment with a cost of £480,000 to Silver Point Co. The 5-year lease calls for a
10% down payment and equal annual payments at the end of each year. The equipment
has an expected useful life of 5 years. If the selling price of the equipment is £780,000,
and the rate implicit in the lease is 8%, what are the equal annual payments?
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. £175,820
b. £162,795
c. £181,972
d. £195,356
Accounting for Leases
21 – 17
75. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
What type of lease is this from Alt Corporation’s viewpoint?
a. Operating lease
b. Finance lease
c. Sales-type lease
d. Direct-financing lease
76. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
If Alt could account for the lease as a finance lease, what expenses would be recorded as
a consequence of the lease during the fiscal year ended December 31, 2018?
a. Depreciation Expense
b. Lease Expense
c. Interest Expense
d. Depreciation Expense and Interest Expense
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 18
77. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
If the present value of the future lease payments is €1,600,000 at January 1, 2018, what is
the amount of the reduction in the lease liability for Alt Corp. in the second full year of the
lease if Alt Corp. accounts for the lease as a finance lease? (Rounded to the nearest
dollar.)
a. €414,852
b. €446,852
c. €472,350
d. €456,350
78. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
From the viewpoint of Yates, what type of lease agreement exists?
a. Operating lease
b. Finance lease
c. Sales-type lease
d. Direct-financing lease
Accounting for Leases
21 – 19
79. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
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. €574,864
b. €1,572,563
c. €1,600,000
d. €1,724,592
80. Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for
the purpose of leasing a machine to be used in its manufacturing operations. The
following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of
€574,864 are due on January 1 of each year.
(b) The fair value of the machine on January 1, 2018, is €1,600,000. The machine has a
remaining economic life of 10 years, with no salvage value. The machine reverts to the
lessor upon the termination of the lease.
(c) Alt depreciates all machinery it owns on a straight-line basis.
(d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8%
implicit rate used by Yates.
(e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a
suit which is sufficiently material to make collectibility of future lease payments doubtful.
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. Lease Revenue only
b. Interest Revenue only
c. Depreciation Expense only
d. Lease Revenue and Depreciation Expense
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 20
81. Hull Co. bought equipment and immediately leased it to Riggs Company on May 1, 2018.
At that time the collectibility of the minimum lease payments was not probable. The lease
expires on May 1, 2019. Riggs could have bought the equipment from Hull for $5,600,000
instead of leasing it. Hull’s accounting records showed a book value for the equipment on
May 1, 2018, of $4,900,000. Hull’s depreciation on the equipment in 2018 was $630,000.
During 2018, Riggs paid $1,260,000 in rentals to Hull for the 8-month period. Hull incurred
maintenance and other related costs under the terms of the lease of $112,000 in 2018.
After the lease with Riggs expires, Hull will lease the equipment to another company for
two years.
The income before income taxes derived by Hull from this lease for the year ended
December 31, 2018, should be
a. $518,000.
b. $630,000.
c. $1,148,000.
d. $1,260,000.
82. On January 2, 2018, Hanson Leasing Company leases equipment to Foley Co. with 5
equal annual payments of £240,000 each, payable beginning January 2, 2018. Foley Co.
agrees to guarantee the £150,000 residual value of the asset at the end of the lease term.
The expected value of the residual is £0. Foley’s incremental borrowing rate is 10%,
however it knows that Hanson’s implicit interest rate is 8%. The journal entry Hanson
makes at January 2, 2018 includes a debit to right-of-use asset for?
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. £897,674.
b. £1,034,910.
c. £1,061,013.
d. £1,137,673.
83. Mays Company has a machine with a cost of €750,000 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 €75,000. If the lessor’s interest rate
implicit in the lease is 12%, the six beginning-of–the-year lease payments would be
a. €162,874.
b. €154,623.
c. €146,587.
d. €125,000.
Accounting for Leases
21 – 21
84. On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5
equal annual payments of €160,000 each, payable beginning January 2, 2018. Brick Co.
agrees to guarantee the €150,000 residual value of the asset at the end of the lease term.
The expected value of the residual value is €50,000. 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, 2018 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. Right-of-Use Asset 598,449
Lease Liability 598,449
b. Right-of-Use Asset 758,449
Cash 160,000
Lease Liability 598,449
c. Right-of-Use Asset 689,940
Cash 160,000
Lease Liability 529,940
d. Right-of-Use Asset 707,342
Cash 160,000
Lease Liability 547,342
85. On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5
equal annual payments of €160,000 each, payable beginning January 2, 2018. Brick Co.
agrees to guarantee the €150,000 residual value of the asset at the end of the lease term.
The expected value of the residual value is €50,000. 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, 2019 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 112,124
Interest Expense 47,876
Cash 160,000
b. Lease Liability 117,604
Interest Expense 42,396
Cash 160,000
c. Lease Liability 160,000
Cash 160,000
d. Lease Liability 116,212
Interest Expense 43,788
Cash 160,000
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 22
86. 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 liability accounts have the following balances:
Right-of-Use Asset €400,000
Less accumulated depreciation—finance 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 €11,800, what gain or loss
should Dains record?
a. €2,680 gain
b. €6,280 loss
c. €4,200 loss
d. €11,800 gain
87. Harter Company leased machinery to Stine Company on July 1, 2018, for a ten-year
period expiring June 30, 2028. Equal annual payments under the lease are £250,000 and
are due on July 1 of each year. The first payment was made on July 1, 2018. The rate of
interest used by Harter and Stine is 9%. The lease receivable before the first payment is
£1,750,000 and the cost of the machinery on Harter’s accounting records was £1,550,000.
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, 2018?
a. £157,500
b. £135,000
c. £67,500
d. £0
88. Pye Company leased equipment to the Polan Company on July 1, 2018, for a ten-year
period expiring June 30, 2028. Equal annual payments under the lease are €240,000 and
are due on July 1 of each year. The first payment was made on July 1, 2018. The rate of
interest contemplated by Pye and Polan is 9%. The lease receivable before the first
payment is €1,680,000 and the cost of the equipment on Pye’s accounting records was
€1,488,000. 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, 2018?
a. €192,000 and €151,200
b. €192,000 and €129,600
c. €192,000 and €64,800
d. €0 and €0
Accounting for Leases
21 – 23
89. Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc.,
on July 1, 2018. The lease is appropriately accounted for as a sales-type lease by Metro
and as a finance lease by Sands. The lease is for a 10-year period (the useful life of the
asset) expiring June 30, 2028. The first of 10 equal annual payments of €828,000 was
made on July 1, 2018. Metro had purchased the equipment for €5,250,000 on January 1,
2018, and established a list selling price of €7,200,000 on the equipment. Assume that the
present value at July 1, 2018, of the rent payments over the lease term discounted at 8%
(the appropriate interest rate) was €6,000,000.
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,
2018?
a. €300,000 and €206,880
b. €300,000 and €240,000
c. €3,600,000 and €206,880
d. €3,600,000 and €160,000
90. Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc.,
on July 1, 2018. The lease is appropriately accounted for as a sales-type lease by Metro
and as a finance lease by Sands. The lease is for a 10-year period (the useful life of the
asset) expiring June 30, 2028. The first of 10 equal annual payments of €828,000 was
made on July 1, 2018. Metro had purchased the equipment for €5,250,000 on January 1,
2018, and established a list selling price of €7,200,000 on the equipment. Assume that the
present value at July 1, 2018, of the rent payments over the lease term discounted at 8%
(the appropriate interest rate) was €6,000,000.
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, 2018?
a. €0 and €137,920
b. €750,000 and €206,880
c. €750,000 and €240,000
d. €1,200,000 and €480,000
91. Roman Company leased equipment from Koenig Company on July 1, 2018, for an eight-
year period expiring June 30, 2026. Equal annual payments under the lease are £800,000
and are due on July 1 of each year. The first payment was made on July 1, 2018. The rate
of interest contemplated by Roman and Koenig is 8%. The cash lease receivable before
the first payment is £4,965,000 and the cost of the equipment on Koenig’s accounting
records was £4,400,000. 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, 2018?
a. £0 and £0
b. £0 and £166,600
c. £565,000 and £166,600
d. £565,000 and £198,600
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 24
92. Gage Co. purchases land and constructs a service station and car wash for a total of
€540,000. At January 2, 2018, when construction is completed, the facility and land on
which it was constructed are sold to a major oil company for €600,000 and immediately
leased from the oil company by Gage. Fair value of the land at time of the sale was
€60,000. 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, 2018 €600,000.00
Dec. 31, 2018 €97,646.71 €60,000.00 €37,646.71 562,353.29
Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91
Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39
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
93. Gage Co. purchases land and constructs a service station and car wash for a total of
€540,000. At January 2, 2018, when construction is completed, the facility and land on
which it was constructed are sold to a major oil company for €600,000 and immediately
leased from the oil company by Gage. Fair value of the land at time of the sale was
€60,000. 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, 2018 €600,000.00
Dec. 31, 2018 €97,646.71 €60,000.00 €37,646.71 562,353.29
Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91
Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39
What is the discount rate implicit in the amortization schedule presented above?
a. 12%
b. 10%
c. 8%
d. 6%
Accounting for Leases
21 – 25
94. Gage Co. purchases land and constructs a service station and car wash for a total of
€540,000. At January 2, 2018, when construction is completed, the facility and land on
which it was constructed are sold to a major oil company for €600,000 and immediately
leased from the oil company by Gage. Fair value of the land at time of the sale was
€60,000. 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, 2018 €600,000.00
Dec. 31, 2018 €97,646.71 €60,000.00 €37,646.71 562,353.29
Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91
Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39
The total lease-related expenses recognized by the lessee during 2019 is
a. €96,000.
b. €97,647.
c. €110,235.
d. €92,235.
95. Gage Co. purchases land and constructs a service station and car wash for a total of
€540,000. At January 2, 2018, when construction is completed, the facility and land on
which it was constructed are sold to a major oil company for €600,000 and immediately
leased from the oil company by Gage. Fair value of the land at time of the sale was
€60,000. 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, 2018 €600,000.00
Dec. 31, 2018 €97,646.71 €60,000.00 €37,646.71 562,353.29
Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91
Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39
What is the amount of the lessee’s liability to the lessor after the December 31, 2020
payment?
a. €600,000
b. €562,353
c. €520,942
d. €475,389
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 26
*96. Gage Co. purchases land and constructs a service station and car wash for a total of
€540,000. At January 2, 2018, when construction is completed, the facility and land on
which it was constructed are sold to a major oil company for €600,000 and immediately
leased from the oil company by Gage. Fair value of the land at time of the sale was
€60,000. 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, 2018 €600,000.00
Dec. 31, 2018 €97,646.71 €60,000.00 €37,646.71 562,353.29
Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91
Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39
The total lease-related income recognized by the lessee during 2019 is which of the
following?
a. € -0-
b. €4,000
c. €6,000
d. €60,000
*97. On June 30, 2018, Falk Co. sold equipment to an unaffiliated company for £2,000,000.
The equipment had a book value of £1,080,000 and a remaining useful life of 10 years.
That same day, Falk leased back the equipment at £12,000 per month for 5 years with no
option to renew the lease or repurchase the equipment. Falk’s lease expense for this
equipment for the year ended December 31, 2018, should be
a. £288,000.
b. £72,000.
c. £120,000.
d. £96,000.
Multiple Choice Answers—Computational
Item
Ans
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Item
Ans.
Accounting for Leases
21 – 27
Future Value of Ordinary Annuity of 1
Test Bank for Intermediate Accounting, Sixteenth Edition
21 – 28
MULTIPLE CHOICE—CPA Adapted
98. 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 Finance lease
b. Operating lease Operating lease
c. Finance lease Finance lease
d. Finance lease Operating lease
99. On December 31, 2018, Burton, Inc. leased machinery with a fair value of €1,575,000
from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual
payments of €300,000 beginning December 31, 2018. The lease is appropriately
accounted for by Burton as a finance 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.
In its December 31, 2018 statement of financial position, Burton should report a lease
liability of
a. €1,137,240.
b. €1,275,000.
c. €1,408,770.
d. €1,437,240.
100. On December 31, 2018, Harris Co. leased a machine from Catt, Inc. for a five-year period.
Equal annual payments under the lease are €2,100,000 (including €100,000 annual
executory costs) and are due on December 31 of each year. The first payment was made
on December 31, 2018, and the second payment was made on December 31, 2019. The
five lease payments are discounted at 10% over the lease term. The present value of
lease payments at the inception of the lease and before the first annual payment was
€8,756,727. The lease is appropriately accounted for as a finance lease by Harris. In its
December 31, 2019 statement of financial position, Harris should report a lease liability of
a. €6,340,000.
b. €6,240,000.
c. €5,706,000.
d. €5,222,400.
101. A lessee had a ten-year finance 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.
Accounting for Leases
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102. On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy
duty drill press. The lease stipulated annual payments of €300,000 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 finance 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 €1,800,000, based on implicit interest of 10%.
In its 2018 income statement, what amount of interest expense should Hernandez report
from this lease transaction?
a. €0
b. €135,000
c. €150,000
d. €180,000
103. On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy
duty drill press. The lease stipulated annual payments of €300,000 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 finance lease. The drill press has an estimated
useful life of 15 years, with no salvage value. Hernandez uses straight-line amortization
for all of its plant assets. Aggregate lease payments were determined to have a present
value of €1,800,000, based on implicit interest of 10%.
In its 2018 income statement, what amount of depreciation expense should Hernandez report
from this lease transaction?
a. €300,000
b. €240,000
c. €180,000
d. €120,000
104. 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.
105. Torrey Co. manufactures equipment that is sold or leased. On December 31, 2018, Torrey
leased equipment to Dalton for a five-year period ending December 31, 2023, at which
date ownership of the leased asset will be transferred to Dalton. Equal payments under
the lease are £1,100,000 (including £100,000 executory costs) and are due on December
31 of each year. The first payment was made on December 31, 2018. Collectibility of the
remaining lease payments is probable. The lease receivable before the first payment is
£3,850,000, and cost is £3,000,000. For the year ended December 31, 2018, what
amount of income should Torrey realize from the lease transaction?
a. £850,000
b. £1,100,000
c. £1,150,000
d. £1,650,000
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*106. Jamar Co. sold its headquarters building at a gain, and simultaneously leased back the
building. The lease was reported as a finance lease. At the time of the sale, the gain
should be reported as
a. a deferred gain.
b. comprehensive income net of income tax.
c. a separate component of equity.
d. operating income.
107. Farm Co. leased equipment to Union Co. on July 1, 2018, and properly recorded the
sales-type lease at €135,000, the present value of the lease payments discounted at 10%.
The first of eight annual lease payments of €20,000 due at the beginning of each year of
the lease term was received and recorded on July 3, 2018. Farm had purchased the
equipment for €110,000. What amount of interest revenue from the lease should Farm
report in its 2018 income statement?
a. €0
b. €5,500
c. €5,750
d. €6,750
Multiple Choice Answers—CPA Adapted
Item
Ans.
Item
Ans.
Item
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Ans.
Accounting for Leases
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DERIVATIONS — Computational
No. Answer Derivation
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DERIVATIONS — Computational (cont.)
No. Answer Derivation
Accounting for Leases
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Test Bank for Intermediate Accounting, Sixteenth Edition
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DERIVATIONS — Computational (cont.)
No. Answer Derivation
DERIVATIONS — CPA Adapted
No. Answer Derivation
Accounting for Leases
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BRIEF EXERCISES
BE. 21–108—Finance lease (Essay).
Explain a finance lease from a lessee’s perspective.
Solution 21-108
BE. 21–109—Finance lease amortization and journal entries.
Hughey Co. as lessee records a finance lease of machinery on January 1, 2018. The seven
annual lease payments of €875,000 are made at the end of each year. The present value of the
lease payments at 10% is €4,260,000. 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 2018 and 2019.
(b) Prepare all of Hughey’s journal entries for 2018.
Solution 21-109
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Solution 21-109 (cont.)
BE. 21–110—Operating lease.
Maris Co. purchased a machine on January 1, 2018, for €2,500,000 for the express purpose of
leasing it. The machine is expected to have a five-year life, no salvage value, and be depreciated
on a straight-line monthly basis. On April 1, 2018, under a cancelable lease, Maris leased the
machine to Dunbar Company for €750,000 a year for a four-year period ending March 31, 2022.
Maris incurred total maintenance and other related costs under the provisions of the lease of
€25,000 relating to the year ended December 31, 2018. Harley paid €750,000 to Maris on April 1,
2018.
Instructions
Assuming an operating lease, what should be the income before income taxes derived by
Maris Co. from this lease for the year ended December 31, 2018?
Solution 21-110
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EXERCISES
Ex. 21-111—Lease classification tests.
What are the lease classification tests used to determine whether a lessor should use the finance
lease approach or the operating lease approach?
Solution 21-111
Ex. 21-112—Direct-financing lease and sales-type lease.
Explain the differences between a direct-financing lease and a sales-type lease.
Solution 21-112
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Ex. 21-113—Lessor accounting—sales-type lease.
Hayes Corp. is a manufacturer of truck trailers. On January 1, 2018, Hayes Corp. leases ten
trailers to Lester Company under a six-year noncancelable lease agreement. The following
information about the lease and the trailers is provided:
1. Equal annual payments that are due on January 1 each year provide Hayes Corp. with an
8% return on net investment (present value factor for 6 periods at 8% is 4.99271).
2. Titles to the trailers pass to Lester at the end of the lease.
3. The fair value of each trailer is €60,000. The cost of each trailer to Hayes Corp. is €54,000.
Each trailer has an expected useful life of nine years.
4. Collectibility of the lease payments is probable.
Instructions
(a) What type of lease is this for the lessor? Discuss.
(b) Calculate the annual lease payment. (Round to nearest dollar.)
(c) Prepare a lease amortization schedule for Hayes Corp. for the first three years.
(d) Prepare the journal entries for the lessor for 2018 to record the lease agreement, the receipt
of the lease rentals, and the recognition of revenue (assume the use of a perpetual
inventory method and round all amounts to the nearest dollar).
Solution 21-113
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Test Bank for Intermediate Accounting, Sixteenth Edition
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*Ex. 21-114—Sale-Leaseback.
On January 1, 2018, Haley Corporation sold a Machine to Quick Finance for €140,000 and
immediately leased it back. The machine was carried on Haley’s books at €112,000. The term of
the lease is 3 years, there is no bargain purchase option, and title does not transfer to Haley at
lease-end. The lease requires three equal rental payments of €34,784 at the end of each year
(first payment on January 1, 2019). The appropriate rate of interest is 6%, the machine has a
useful life of 5 years, and the residual value at the end of the lease term is expected to be
€56,000, none of which is guaranteed.
Instructions
Prepare Haley’s 2018 journal entries.
Solution 21-114
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*Ex. 21-115—Sale-Leaseback.
Assume that on January 1, 2018, Wildcat Corporation sells equipment to Wichita Finance Co. for
£1,700,000 and immediately leases back the equipment. The relevant information is as follows.
1. The equipment was carried on Wildcats books at a value of £1,500,000.
2. The term of the non-cancelable lease is 3 years; title will not transfer to Wildcats, and the
expected residual value at the end of the lease is £1,125,000, all of which is unguaranteed.
3. The lease agreement requires equal rental payments of £277,635 at the beginning of each
year.
4. The incremental borrowing rate for Wildcat is 7%. Wildcat is aware that Wichita Finance set
the annual rental to ensure a rate of return of 7%.
5. The equipment has a fair value of £1,700,000 on January 1, 2018, and an estimated
economic life of 10 years.
Instructions
Prepared the journal entries for both the lessee and the lessor for 2018 to reflect the sale and
leaseback agreement.
*Solution 21-115
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*Solution 21-115 (Continued)
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PROBLEMS
Pr. 21-116—Lessee accounting—finance lease.
Eubank Company, as lessee, enters into a lease agreement on July 1, 2018, for equipment. The
following data are relevant to the lease agreement:
1. The term of the noncancelable lease is 4 years. Payments of €978,446 are due on July 1 of
each year.
2. The fair value of the equipment on July 1, 2018 is €3,500,000. The equipment has an
economic life of 6 years with no salvage value.
3. Eubank depreciates similar machinery it owns on the sum–of–the-years’-digits basis.
4. The lessee pays all executory costs.
5. Eubank’s incremental borrowing rate is 10% per year. The lessee is aware that the lessor
used an implicit rate of 8% in computing the lease payments (present value factor for 4
periods at 8%, 3.57710; at 10%, 3.48685).
Instructions
(a) Indicate the type of lease Eubank Company has entered into and what accounting treatment
is applicable.
(b) Prepare the journal entries on Eubank’s books that relate to the lease agreement for the
following dates: (Round all amounts to the nearest dollar. Include a partial amortization
schedule.)
1. July 1, 2018.
2. December 31, 2018.
3. July 1, 2019.
4. December 31, 2019.
Solution 21-116
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Solution 21-116 (cont.)
Pr. 21-117—Lessee accounting—finance lease.
Krause Company on January 1, 2018, enters into a nine-year noncancelable lease for equipment
having an estimated useful life of 10 years and a fair value to the lessor, Daly Corp., at the
inception of the lease of €4,000,000. Krause’s incremental borrowing rate is 8%. Krause uses the
straight-line method to depreciate its assets. The lease contains the following provisions:
1. Rental payments of €266,000 for property taxes, payable at the beginning of each six-month
period.
2. An option allowing the lessor to extend the lease one year beyond the lease term.
3. A guarantee by Krause Company that Daly Corp. will realize €200,000 from selling the asset
at the expiration of the lease. However, the actual residual value is expected to be €120,000.
Instructions
(a) What kind of lease is this to Krause Company?
(b) What should be considered the lease term?
(c) What is the present value of the lease payments (1) for classification of the lease and (2) for
measurement of the lease liability? (PV factor for annuity due of 20 semi-annual payments
at 8% annual rate, 14.13394; PV factor for amount due in 20 semi-annual interest periods at
8% annual rate, .45639.) (Round to nearest dollar.)
(d) What journal entries would Krause record during the first year of the lease? (Include an
amortization schedule through 1/1/19 and round to the nearest dollar.)
Accounting for Leases
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Solution 21-117
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Solution 21-117 (cont.)
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IFRS QUESTIONS
True/False
1. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease
payments due in years 1 through 5.
2. IFRS distinguishes between sales-type and direct financing leases for lessors.
3. IFRS requires lessees to use their incremental rate, unless the implicit rate is known by the
lessee and the implicit rate is lower than the incremental rate.
4. IFRS requires lessees to recognize a right-of-use asset and related liability for leases with
terms longer than one year.
5. Because IFRS is very general in its provisions for lease accounting, the required disclosures
for leases under IFRS are more detailed and extensive than those required under GAAP.
Short Answer
6. Briefly describe some of the similarities and differences between GAAP and IFRS with
respect to the accounting for leases.
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