PVE-0001
The Question: present value of the minimum lease payments should be used by the lessee in the determination of a(n) A. B. C. D. Capital lease liability Yes Yes No No Operating lease liability No Yes Yes No
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
A. Answer A is correct. Per SFAS 13, the present value of the minimum lease payments should be used to determine the liability under a capital lease. Under an operating lease, a liability arises when rent expense is recorded but has not been paid. Furthermore, it is recorded at the actual amount of cash to be paid, not its present value.
Question: PVE-0002
Lease Y contains a bargain purchase option and the lease term is equal to 75% of the estimated economic life of the leased property. Lease Z contains a bargain purchase option and the lease term is equal to less than 75% of the estimated economic life of the leased property. How should the lessee classify these leases? A. B. C. D. Lease Y Operating lease Operating lease Capital lease Capital lease Lease Z Operating lease Capital lease Capital lease Operating lease
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
C. Answer C is correct. SFAS 13 states that a lease shall be classified as a capital lease by the lessee if one or more of the four criteria are met. The four criteria are as follows: 1. 2. 3. 4. Lease transfers ownership to the lessee during lease term Lease contains a bargain purchase option Lease term is 75% or more of the economic useful life of the property Present value of the minimum lease payment equals 90% or more of FMV of the leased property
Since both Lease Y and Lease Z meet at least one of the criteria, both are considered capital leases.
Question: PVE-0003
On 1/31/08, Clay Company leased a new machine from Saxe Corp. The following data relate to the lease transaction at its inception: Lease term Annual rental payable at beginning of each lease year Useful life of machine Implicit interest rate Present value of an annuity of 1 in advance for 10 periods at 10% Present value of annuity of 1 in arrears for 10 periods at 10% Fair value of the machine 10 years $50,000 15 years 10% 6.76 6.15 $400,000
The lease has no renewal option, and the possession of the machine reverts to Saxe when the lease terminates. At the inception of the lease, Clay should record a lease liability of
Answers
A: $400,000 B: $338,000 C: $307,500 D: $0
Answer Explanations
D. Answer D is correct. At the inception of a lease, the lessee records a lease liability if the lease is considered to be a capital lease. To be considered a capital lease, a lease must satisfy any one of the four criteria specified in SFAS 13. This lease does not satisfy any of the four criteria. The lease has no bargain purchase option and does not transfer title. The lease term is not 75% or more of the useful life (10 years out of 15 years is 67%) and the PV of the lease payments is not 90% or more of the FMV of the asset [(6.76 x $50,000) / $400,000 = 84.5%]. Therefore, this is an operating lease, not a capital lease, and no liability is recorded at the lease's inception.
Question: PVE-0004
The Morn Company leased equipment to the Lizard Company on May 1, 2007. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2009. Lizard could have bought the equipment from Morn for $900,000 instead of leasing it. Morns accounting records showed a book value for the equipment on May 1, 2007, of $800,000. Morns depreciation on the equipment in 2007 was $200,000. During 2007 Lizard paid $240,000 in rentals to Morn. Morn incurred maintenance and other related costs under the terms of the lease of $18,000 in 2007. After the lease with Lizard expires, Morn will lease the equipment to the Cold Company for another 2 years. The income before income taxes derived by Morn from this lease for the year ended December 31, 2007, should be
Answers
A: $ 22,000 B: $100,000 C: $122,000 D: $240,000
Answer Explanations
A. Answer A is correct. The lease shall be accounted for as an operating lease because none of the four requirements applicable to both lessees and lessors is met. Even if one or more was met, the lease would still be classified as an operating lease as the payments are not reasonably predictable (SFAS 13). The calculation for lease income for 2007 would be as follows:
Rental income Less: 2007 depreciation Maintenance costs Income from lease for 2007
$240,000 (200,000) (18,000) $ 22,000
Question: PVE-0005
Rent received in advance by the lessor for an operating lease should be recognized as revenue
Answers
A: When received. B: At the leases inception. C: In the period specified by the lease. D: At the leases expiration.
Answer Explanations
A. Answer A is incorrect because when the cash is received is irrelevant since revenue recognition is on the accrual basis. B. Answer B is incorrect because the earnings process is not complete at the lease's inception. C. Answer C is correct. Under an operating lease rental revenue is to be recognized in each accounting period on a straight-line basis unless another systematic and rational basis is more representative of the decline in the asset's service potential. D. Answer D is incorrect because rental revenue is earned daily by the lessor as the property is being leased; therefore, deferring revenue recognition until the lease's expiration would violate the revenue recognition principle.
Question: PVE-0006
Howard Company sublet a portion of its warehouse for 5 years at an annual rental of $18,000, beginning on May 1, 2007. The tenant paid 1 years rent in advance, which Howard recorded as a credit to unearned rental income. Howard reports on a calendaryear basis. The adjustment on December 31, 2007, should be Dr. A. B. C. D. No entry Unearned rental income Rental income Rental income Unearned rental income Unearned rental income Rental income $ 6,000 $ 6,000 $ 6,000 $ 6,000 $12,000 $12,000 Cr.
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
D. Answer D is correct. The solutions approach is to determine how much of the annual rental payment is earned income and how much should be deferred to the next period. The amount earned this period is calculated by multiplying the annual payments by that portion of the year that has expired since May 1, 2007 ($18,000 x 8/12 = $12,000). The adjusting entry is
Unearned rental income Rental income
12,000 12,000
Question: PVE-0007
On October 1, 2007, Dean Company leased office space at a monthly rental of $30,000 for 10 years expiring September 30, 2017. As an inducement for Dean to enter into the lease, the lessor permitted Dean to occupy the premises rent-free from October 1 to December 31, 2007. For the year ended December 31, 2007, Dean should record rent expense of
Answers
A: $0 B: $29,250 C: $87,750 D: $90,000
Answer Explanations
C. Answer C is correct. SFAS 13 states that rent on operating leases should be expensed on a straight-line basis unless another method is better suited to the particular benefits and costs associated with the lease. In this lease, the lessee must pay rent of $30,000 monthly for 10 years less the first 3 months, or 117 months (120 3). Therefore, total rent expense for the 10 years is $3,510,000 (117 x $30,000). Recognizing rent expense on a straight-line basis, 2007 rent expense is $87,750 ($3,510,000 x 3/120).
Question: PVE-0008
Initial direct costs are
Answers
A: Expensed currently for sales-type leases. B: Capitalized and amortized to expense over the lease term for all leases. C: Capitalized only if the related lease qualifies as a capital lease.
D: Presented on the balance sheet as a contra account to capitalized leased assets.
Answer Explanations
A. Answer A is correct. Initial direct costs are costs incurred in connection with the negotiation and consummation of leases, such as legal fees, commissions, etc. For salestype leases, profit or loss is recognized upon inception of the lease. In keeping with the matching principle, the costs of consummating that lease should be taken into income at the same time as the resulting profit or loss. Therefore, initial direct costs for sales-type leases are expensed currently. B. Answer B is incorrect because initial direct costs are not capitalized for all types of leases. C. Answer C is incorrect because initial direct costs are capitalized and amortized on a straight-line basis over the lease term for operating leases. Initial direct costs of capital leases may or may not be capitalized. For direct financing leases, these costs are capitalized and amortized by the interest method as a decrease in yield. Conversely, initial direct costs of sales-type leases are not capitalized. D. Answer D is incorrect. Initial direct costs which are expensed do not appear on the balance sheet. Capitalized initial direct costs are shown separately as a deferred charge on the lessor's balance sheet, net of accumulated amortization. They do not reduce the amount of the capitalized leased asset.
Question: PVE-0009
When should a lessor recognize in income a nonrefundable lease bonus paid by a lessee on signing an operating lease?
Answers
A: When received. B: At the inception of the lease. C: At the expiration of the lease. D: Over the life of the lease.
Answer Explanations
D. Answer D is correct. SFAS 13 specifies that, in an operating lease, the lesser should recognize rental revenues on a straight-line basis. This means that a lease bonus should be recorded as unearned revenue and recognized as rental revenue over the life of the lease.
Question: PVE-0010
Arrow Company purchased a machine on January 1, 2007, for $1,440,000 for the purpose of leasing it. The machine is expected to have an 8-year life from date of purchase, no residual value, and be depreciated on the straight-line basis. On February 1, 2007, the machine was leased to Baxter Company for a 3-year period ending January 31, 2010, at a monthly rental of $30,000. Additionally, Baxter paid $72,000 to Arrow on February 1, 2007, as a lease bonus. What is the amount of income before income taxes that Arrow should report on this leased asset for the year ended December 31, 2007?
Answers
A: $172,000 B: $187,000 C: $222,000 D: $237,000
Answer Explanations
A. Answer A is correct. Income from the lease is the monthly rental plus a proportionate fraction of the lease bonus less any depreciation expense.
Rental income Lease bonus income Depreciation expense Income from leased asset
= = =
11 months x $30,000 $72,000 x 11/36 $1,440,000/8 years
= = =
$330,000 $ 22,000 ($180,000) $172,000
Note that the lease bonus is recognized as income proportionately over the 36-month lease period. The leased asset is depreciated for a full year since it has an 8-year life from the date of purchase (January 1). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0011
On January 1, 2007, Glen Co. leased a building to Dix Corp. for a 10-year term at an annual rental of $50,000. At inception of the lease, Glen received the first 2 years rent of $100,000 and a security deposit of $100,000. This deposit will not be returned to Dix upon expiration of the lease but will be applied to payment of rent for the last 2 years of the lease. What portion of the $200,000 should be shown as a current and long-term liability, respectively, in Glens December 31, 2007 balance sheet? Current liability $0 $ 50,000 $100,000 $100,000 Long-term liability $200,000 $100,000 $100,000 $ 50,000
A. B. C. D.
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. At 1/1/07, Glen would record as a current liability unearned rent of $50,000, and as a long-term liability unearned rent of $150,000. During 2007, the current portion of unearned rent was earned and would be recognized as revenue. At 12/31/07, the portion of the long-term liability representing the second year's rent ($50,000) would be reclassified as current, leaving as a long-term liability, the $100,000 representing the last 2 years' rent. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0012
During January 2007, Vail Co. made long-term improvements to a recently leased building. The lease agreement provides for neither a transfer of title to Vail nor a bargain purchase option. The present value of the minimum lease payments equals 85% of the buildings market value, and the lease term equals 70% of the buildings economic life. Should assets be recognized for the building and the leasehold improvements? Building Leasehold improvements
A. B. C. D.
Yes No Yes No
Yes Yes No No
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. Per SFAS 13, a lease is classified as a capital lease by the lessee if the lease terms meet any one of the following criteria: (1) transfer of ownership to the lessee by the end of the lease term; (2) bargain purchase option; (3) lease term greater than or equal to 75% of the economic life of the property; or (4) the present value of the minimum lease payments is greater than or equal to 90% of the property's fair market value. Since the terms of Vail's lease do not meet any of the criteria, the lease should be accounted for as an operating lease. Thus, Vail should not recognize the building as an asset. However, Vail should recognize the cost of leasehold improvements as assets because in an operating lease, these costs are capitalized and amortized over the shorter of their useful lives or the term of the lease. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0013
On December 1, 2007, Branch Corporation leased office space for 10 years at a monthly rental of $15,000. On that date Branch paid the landlord the following amounts: Rent deposit First months rent Last months rent Installation of new walls and offices $ 15,000 15,000 15,000 96,000 $141,000
The entire amount of $141,000 was charged to rent expense in 2007. What amount should Branch have charged to expense for the year ended December 31, 2007?
Answers
A: $15,000 B: $15,800 C: $30,800 D: $96,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. The leasehold improvement amortization is $9,600 a year ($96,000 10 yrs.) or $800 per month ($9,600 12 mos.). Accordingly, December's expenses should have been $15,800, and $95,200 of leasehold improvements should be deferred and amortized over the remainder of the lease. The rent deposit of $15,000 and the last month's rent of $15,000 should be set up as prepaid assets as shown in the following journal entry.
Leasehold improvements Rent expense Rent deposit Prepaid rent Cash Leasehold imp. amort. Leasehold improv.
96,000 15,000 15,000 15,000 141,000 800 800
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0014
On January 1, 2005, Nobb Corp. signed a 12-year lease for warehouse space. Nobb has an option to renew the lease for an additional 8-year period on or before January 1, 2009. During January 2007, Nobb made substantial improvements to the warehouse. The cost of these improvements was $540,000, with an estimated useful life of 15 years. At December 31, 2007, Nobb intended to exercise the renewal option. Nobb has taken a full years amortization on this leasehold. In Nobbs December 31, 2007 balance sheet, the carrying amount of this leasehold improvement should be
Answers
A: $486,000
B: $504,000 C: $510,000 D: $513,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. The cost of the leasehold improvements ($540,000) should be amortized over the remaining life of the lease, or over the useful life of the improvements, whichever is shorter. The remaining life of the lease should include periods covered by a renewal option if it is probable that the option will be exercised. In this case, the remaining life of the lease is 18 years (12 years of original lease + 8 years in option period 2 years past), and the useful life of the improvements is 15 years. Therefore, amortization is based on a 15-year life ($540,000 15 = $36,000). The 12/31/07 carrying amount is $504,000 ($540,000 $6,000). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0015
When equipment held under an operating lease is subleased by the original lessee, the original lessee would account for the sublease as a(n)
Answers
A: Operating lease. B: Sales-type lease. C: Direct financing lease. D: Capital lease.
Answer Explanations
A. Answer A is correct. A sublease arises when the lease agreement between the two original parties remains in effect, and the leased property is released to a third party by the original lessee. Per SFAS 13, when equipment held under an operating lease is subleased by the original lessee, the sublease is still considered to be an operating lease by the original lessee. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0016
In a lease that is recorded as a direct financing lease by the lessor, the difference between the gross investment in the lease and the sum of the present values of the components of the gross investment should be recognized as income
Answers
A: In full at the leases expiration. B: In full at the leases inception. C: Over the period of the lease using the interest method of amortization. D: Over the period of the lease using the straight-line method of amortization.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. For a direct financing lease, the difference between the gross investment in the lease and the sum of the present values of the components of the gross investment is, by definition, unearned interest income. Per SFAS 98, the unearned interest income is recognized as income over the lease term so as to produce a constant rate of return on the net investment using the effective interest method of amortization. Other methods of amortization are allowed by SFAS 98 provided the results are not materially different from those obtained by applying the prescribed method. Because no information is given concerning such materiality, answer C is the best answer. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0017
On January 1, 2007, JCK Co. signed a contract for an 8-year lease of its equipment with a 10-year life. The present value of the 16 equal semiannual payments in advance equaled 85% of the equipments fair value. The contract had no provision for JCK, the lessor, to give up legal ownership of the equipment. Should JCK recognize rent or interest revenue in 2008, and should the revenue recognized in 2008 be the same or smaller than the revenue recognized in 2007? 2008 revenues recognized Rent Rent Interest Interest 2008 amount recognized compared to 2007 The same Smaller The same Smaller
A. B. C. D.
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. This lease qualifies as a direct financing lease; therefore interest revenue will be recognized rather than rent revenue. Had the lease qualified as an operating lease, rent revenue would have been recognized. The lessor's criteria for direct financing classification is as follows: 1. 2. 3. 4. The lease transfers ownership to the lessee, at the end of the lease The lease contains a bargain purchase option The lease term is > 75% of an asset's economic life The present value of the minimum lease payments is > 90% of the fair market value of the leased asset.
In addition, collectibility of the minimum lease payments must be predictable and there may be no important uncertainties concerning costs yet to be incurred by the lessee. Since the question is silent in this regard, we will assume that the latter conditions are met. Recall that if one of the first four criteria are met, the lease is treated as a capital lease. In this case, since the lease term is for 80% of the asset's economic life, test (3) is met, and the lease is properly treated as a capital lease. In addition, the amount of interest revenue will be smaller in 2008 than the revenue in 2007. This result occurs because the present value of the minimum lease payments or carrying value of the obligation decreases each year as lease payments are received. As this occurs, the amount of interest revenue on the outstanding amount of the investment will decrease as well. Over the course of time, the investment reduction portion of each level payment increases and the amount of interest declines.
Question: PVE-0018
Beth Co. leased equipment to Wolf, Inc. on April 1, 2007. The lease is appropriately recorded as a direct financing lease by Beth. The lease is for an 8-year period expiring March 31, 2015. The first equal annual payment of $500,000 was made on April 1, 2007. Beth had purchased the equipment on January 1, 2007, for $2,800,000. The equipment
has an estimated useful life of 8 years with no residual value expected. Beth uses straight-line depreciation and takes a full years depreciation in the year of purchase. The cash selling price of the equipment is $2,934,000. Assuming an interest rate of 10%, what amount of interest income should Beth record in 2007 as a result of the lease?
Answers
A: $0 B: $182,550 C: $243,400 D: $280,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. The present value of the eight $500,000 lease payments is given to be $2,934,000 (cash selling price of the equipment). Since $500,000 is paid at the inception of the lease, the book value of the lease payments receivable (total minimum lease payments minus unearned interest income) outstanding for the last 9 months is $2,434,000. The 10% interest thereon is $243,400, but only 3/4 (9 months/12 months) of this amount, or $182,550, is associated with the period ending December 31, 2007. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0019
On August 1, 2007, Kern Company leased a machine to Day Company for a 6-year period requiring payments of $10,000 at the beginning of each year. The machine cost $48,000, which is the fair value at the lease date, and has a useful life of 8 years with no residual value. Kerns implicit interest rate is 10% and present value factors are as follows: Present value of an annuity due of $1 at 10% for 6 periods Present value of an annuity due of $1 at 10% for 8 periods 4.791 5.868
Kern appropriately recorded the lease as a direct financing lease. At the inception of the lease, the gross lease receivables account balance should be
Answers
A: $60,000 B: $58,680
C: $48,000 D: $47,910
Answer Explanations
A. Answer A is correct. Lease payments receivable is debited for the gross investment in the lease, which includes the minimum lease payments plus any unguaranteed residual value. Since there is no residual value in this problem, gross investment is simply the minimum lease payments (6 rentals at $10,000 each, or $60,000). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0020
In a lease that is recorded as a sales-type lease by the lessor, interest revenue
Answers
A: Does not arise. B: Should be recognized over the period of the lease using the interest method. C: Should be recognized over the period of the lease using the straight-line method. D: Should be recognized in full as revenue at the leases inception.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. Per SFAS 13, revenue is to be recognized for a sales-type lease over the lease term in order to produce a constant rate of return on the net investment in the lease. This requires the use of the interest method. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0021
Farm Co. leased equipment to Union Co. on July 1, 2007, 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 was
received and recorded on July 3, 2007. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its 2007 income statement?
Answers
A: $0 B: $5,500 C: $5,750 D: $6,750
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. In this sales-type lease, the lessor would recognize a gross profit on the sale on 7/1/07 of $25,000 ($135,000 present value less $110,000 cost). In addition, interest revenue is recognized in 2007 for the period 7/1 through 12/31. The initial net lease payments receivable on 7/1/07 is $135,000. The first rental payment received on 7/3/07 consists entirely of principal, reducing the net receivable to $115,000 ($135,000 $20,000). Therefore, 2007 interest revenue for the 6-month period is $5,750 ($115,000 x 10% x 6/12). This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0022
Benedict Company leased equipment to Mark, Inc. on January 1, 2007. The lease is for an 8-year period expiring December 31, 2014. The first of 8 equal annual payments of $600,000 was made on January 1, 2007. Benedict had purchased the equipment on December 29, 2006, for $3,200,000. The lease is appropriately accounted for as a salestype lease by Benedict. Assume that the present value at January 1, 2007, of all rent payments over the lease term discounted at a 10% interest rate was $3,520,000. What amount of interest income should Benedict record in 2008 (the second year of the lease period) as a result of the lease?
Answers
A: $261,200 B: $296,000 C: $320,000 D: $327,200
Answer Explanations
A. Answer A is correct. The income recorded would be 10% of the present value of the lease receivable balance outstanding in year 2 (2008). The interest can be computed using an amortization table. Notice that interest is accrued on December 31 of each year, and is paid the following day on January 1. Interest Income Dr (Cr) $ -$292,000 (292,000) 261,200 Amount of payment applied to principal $600,000 -308,000 Carrying value of the lease receivable $3,520,000 2,920,000 2,920,000 2,612,000 2,612,000
Cash received 1/1/07 1/1/07 12/31/07 1/1/08 12/31/08 Interest accrual 600,000 Interest accrual $600,00 0
Interest receivable
(292,000) -(261,200)
Therefore, interest income in 2008 should be $261,200. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0023
Melville Company leased equipment from Rice Corporation on July 1, 2007, for an 8year period expiring June 30, 2015. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, 2007. The rate of interest contemplated by Melville and Rice is 10%. The cash selling price of the equipment is $3,520,000 and the cost of the equipment on Rices accounting records is $2,800,000. Assuming that the lease is appropriately recorded as a sales-type lease, what is the amount of profit on the sale and interest income that Rice should record for the year ended December 31, 2007?
Answers
A: $0 and $0. B: $0 and $146,000. C: $720,000 and $146,000. D: $720,000 and $160,000.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. Melville's gross profit is the difference between the present value of the lease payments, $3,520,000 (which is also the cash selling price of the equipment), and the cost of goods sold ($2,800,000), or $720,000. Interest income is found by multiplying the book value of the receivable from the lessee (total lease payments receivable minus unearned interest) outstanding during 2007 ($3,520,000 initial balance less $600,000 payment made on 7/1/07) times the implicit interest rate (10%) for 1/2 of a year. Therefore, interest income is $146,000 ($2,920,000 x 10% x 1/2). This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0024
Hiller Company manufactures equipment which is sold or leased. On December 31, 2007, Hiller leased equipment to Drake Company for a 5-year period expiring December 31, 2012, at which date ownership of the leased asset is transferred to Drake. Equal payments under the lease are $20,000 and are due on December 31 of each year. The first payment was made on December 31, 2007. Collectibility of the remaining lease payments is reasonably assured, and Hiller has no material cost uncertainties. The normal sales price of the equipment is $77,000 and Hillers cost is $60,000. For the year ended December 31, 2007, how much income should Hiller recognize from the lease transactions?
Answers
A: $0 B: $17,000 C: $20,000 D: $23,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. The lease is a sales-type lease because title to the leased asset transfers, collectibility is reasonably assured, there are no material cost uncertainties, and a manufacturer's profit exists. Therefore, the lessor would recognize sales of $77,000 and cost of sales of $60,000, resulting in a profit of $17,000. There is no interest income in 2007 since the sale occurs on the last day of the year. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0025
What is the cost basis of an asset acquired by a lease which is accounted for as a capital lease?
Answers
A: The net realizable value of the asset determined at the date of the lease agreement plus the sum of the future minimum lease payments under the lease. B: The sum of the future minimum lease payments under the lease. C: The present value of the minimum lease payments under the lease (exclusive of executory costs and any profit thereon) discounted at an appropriate rate. D: The present value of the market price of the asset discounted at an appropriate rate as an amount to be received at the end of the lease.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. When a lease is accounted for as a capital lease, lessees record the lease by debiting the asset and crediting a liability for the present value of the future minimum lease payments (SFAS 13). This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0026
Beal, Inc. intends to lease a machine from Paul Corp. Beals incremental borrowing rate is 14%. The prime rate of interest is 8%. Pauls implicit rate in the lease is 10%, which is known to Beal. Beal computes the present value of the minimum lease payments using
Answers
A: 8% B: 10% C: 12% D: 14%
Answer Explanations
A. Answer A is incorrect. The prime rate (8%) is never used unless it happens to be the same as the incremental or implicit rate. B. Answer B is correct. SFAS 13 states that the lessee should compute the PV of the minimum lease payments using the lesser of the lessee's incremental borrowing rate (14% in this case) or the implicit rate used by the lessor if known (10% in this case). The PV of the minimum lease payments should be computed using the implicit rate of 10% because it is known by the lessee and is lower than the incremental rate. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0027
A lease contains a bargain purchase option. In determining the lessees capitalizable cost at the beginning of the lease term, the payment called for by the bargain purchase option would
Answers
A: Not be capitalized. B: Be subtracted its at present value. C: Be added at its exercise price. D: Be added at its present value.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. Per SFAS 13, minimum lease payments include the rental payments plus the amount of the bargain purchase option if it exists. The amount to be capitalized is the present value of the minimum lease payments. Therefore, the present value of the bargain purchase option would be added to the present value of the rental payments (assumed to be previously calculated) in determining the lessee's capitalizable cost.
Question: PVE-0028
For a capital lease, the amount recorded initially by the lessee as a liability should
Answers
A: Exceed the present value at the beginning of the lease term of minimum lease payments during the lease term. B: Exceed the total of the minimum lease payments during the lease term. C: Not exceed the fair value of the leased property at the inception of the lease. D: Equal the total of the minimum lease payments during the lease term.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. Per SFAS 13, the lessee shall record a capital lease as a debit to an asset account and a credit to a liability account for an amount equal to the present value of the total of the minimum lease payments as of the beginning of the lease term. However, if the amount so determined exceeds the fair value of the leased property at the inception of the lease, the amount recorded as the asset and obligation shall be the fair value of the leased property. D. Answer D is incorrect because the liability must be recorded at the present value of the minimum lease payments. Refer to the correct answer explanation.
Question: PVE-0029
What are the three types of period costs that a lessee experiences with capital leases?
Answers
A: Lease expense, interest expense, amortization expense. B: Interest expense, amortization expense, executory costs. C: Amortization expense, executory costs, lease expense. D: Executory costs, interest expense, lease expense.
Answer Explanations
A. Answer A is incorrect because lease expense is a rental-type expense associated with operating leases. B. Answer B is correct. The three costs incurred by a lessee with respect to capital leases are interest expense, amortization expense, and executory costs. Each payment consists of principal reduction and interest expense. The amount capitalized must be
amortized over the useful life of the asset. Executory costs, such as insurance, maintenance, etc., are borne by the lessee. The basic premise in capital leases is the risks and responsibilities of ownership are transferred from lessor to lessee. C. Answer C is incorrect because lease expense is a rental-type expense that is associated with operating leases. D. Answer D is incorrect because lease expense is a rental-type expense that is associated with operating leases.
Question: PVE-0030
The lessee should amortize the capitalizable cost of the leased asset in a manner consistent with the lessees normal depreciation policy for owned assets for leases that Transfer ownership of the property to the lessee by the end of the lease term No Yes Yes No
A. B. C. D.
Contain a bargain purchase option No No Yes Yes
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. A lease that transfers ownership of the property to the lessee by the end of the lease term and a lease that contains a bargain purchase option are properly classified as capital leases (SFAS 13). Per SFAS 13, if the lease meets either of the above criteria, the asset should be amortized in a manner consistent with the lessee's normal depreciation policy for owned assets because the asset will be used by the lessee for its entire life. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0031
On January 1 of the current year, Tell Co. leased equipment from Swill Co. under a nineyear sales-type lease. The equipment had a cost of $400,000, and an estimated useful life of fifteen years. Semiannual lease payments of $44,000 are due every January 1 and July 1. The present value of lease payments at 12% was $505,000, which equals the sales price of the equipment. Using the straight-line method, what amount should Tell recognize as depreciation expense on the equipment in the current year?
Answers
A: $26,667 B: $33,667 C: $44,444 D: $56,111
Answer Explanations
A. Answer A is incorrect. This amount is calculated by dividing the useful life of the asset into the cost of the asset to the lessor. B. Answer B is incorrect. It is calculated by dividing the useful life of the asset into the present value of the future payments. C. Answer C is incorrect. It is calculated by dividing the cost of the asset to the lessor by the term of the lease. D. Answer D is correct. The leased asset should be recorded at the present value of the future lease payments because it is less than or equal to the fair value of the leased asset. Since the facts do not indicate that title is transferred to the lessee or a bargain purchase or lease option exists, the leased asset should be depreciated over the lesser of the lease term or the assets useful life; $56,111 (=$505,000 9 years).
Question: PVE-0032
The lessees net carrying value of an asset arising from the capitalization of a lease would be periodically reduced by the
Answers
A: Total minimum lease payment. B: Portion of minimum lease payment allocable to interest.
C: Portion of minimum lease payment allocable to reduction of principal. D: Depreciation/amortization of the asset.
Answer Explanations
This answer is incorrect. This answer is incorrect. This answer is incorrect. D. Answer D is correct. lease payment Refer to the correct answer explanation. Refer to the correct answer explanation. Refer to the correct answer explanation. The solutions approach is to prepare the journal entry for the xxx xxx xxx
Capital lease obligation (principal) Interest expense Cash and the journal entry for the lease amortization. Amortization of leased asset Accumulated amortization/depreciation
xxx xxx
Therefore, only the amortization of the leased asset, in accordance with SFAS 13, results in a reduction of the carrying value of the asset.
Question: PVE-0033
The lessees balance sheet liability for a capital lease would be periodically reduced by the total
Answers
A: Minimum lease payment plus the amortization of the related asset. B: Minimum lease payment less the amortization of the related asset. C: Minimum lease payment less the portion of the minimum lease payment allocable to interest. D: Minimum lease payment.
Answer Explanations
A. Answer A is incorrect. Amortization of the asset would be recorded as depreciation expense and has nothing to do with the reduction of the liability. B. Answer B is incorrect. Amortization of the asset would be recorded as depreciation expense and has nothing to do with the reduction of the liability.
C. Answer C is correct. During the lease term, each minimum lease payment consists of both interest and reduction of the lease obligation. Lease amortization produces a constant periodic rate of interest on the remaining balance of the obligation, known as the effective interest method. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0034
Barker Company leased a new machine from Bell Company on July 1, 2007, under a lease with the following pertinent information: Lease term Annual rental payable at the beginning of each lease year Useful life of the machine Implicit interest rate Present value of an annuity of $1 in advance for 10 periods at 14% Present value of $1 for 10 periods at 14% 10 years $30,000 12 years 14% 5.95 0.27
Barker has the option to purchase the machine on July 1, 2017, by paying $40,000, which approximates the expected fair value of the machine on the option exercise date. The cost of the machine on Bells accounting records is $150,000. On July 1, 2007, Barker should record a capitalized leased asset of
Answers
A: $150,000 B: $178,500 C: $189,300 D: $190,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. In a capital lease, the lessee records as an asset the lower of (1) the present value (PV) of the minimum lease payments, or (2) the FMV of the leased asset. Since the FMV is not given, we must assume that the asset is to be recorded at the PV of the minimum lease payments. The minimum lease payments must include any bargain purchase options (BPO). However, the $40,000 purchase option in this problem is not a BPO, since $40,000 approximates the expected fair value of the machine on the option exercise date. Therefore, the PV of the minimum lease payments is $178,500 (5.95 x $30,000). Note that the cost of the asset to the lessor ($150,000) is not relevant to the lessee.
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0035
On December 31, 2007, Neal, Inc. leased machinery with a fair value of $105,000 from Frey Rentals Co. The agreement is a 6-year noncancelable lease requiring annual payments of $20,000 beginning December 31, 2007. The lease is appropriately accounted for by Neal as a capital lease. Neals incremental borrowing rate is 11%. Neal 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, 2007 balance sheet, Neal should report a lease liability of
Answers
A: $75,816 B: $85,000 C: $93,918 D: $95,816
Answer Explanations
A. Answer A is correct. The initial lease liability at 12/31/07, before the 12/31/07 payment, is $95,816 ($20,000 x 4.7908). The liability is recorded at the lower of the FMV of the leased asset ($105,000) or the PV of the minimum lease payments ($95,816). The 10% rate is used to compute PV, rather than the 11% rate, because SFAS 13 states that the discount rate is to be the lessee's incremental borrowing rate, unless the lessor's implicit rate is known and is less than the lessee's incremental borrowing rate. The 12/31/07 payment consists entirely of principal, bringing the 12/31/07 liability down to $75,816 (95,816 $20,000). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0036
Star Company leased a new machine from Fox Company on December 31, 2007, under a lease with the following pertinent information: Lease term 10 years
Annual rental payable at the beginning of each year Useful life of the machine Implicit interest rate Present value of an annuity of $1 in advance for 10 periods at 10% Present value of $1 for 10 periods at 10%
$200,000 15 years 10% 6.76 0.39
Star has the option to purchase the machine on December 31, 2017, by paying $250,000, which is significantly less than the $500,000 expected fair market value of the machine on the option exercise date. Assume that, at the inception of the lease, the exercise of the option appears to be reasonably assured. At the inception of the lease, Star should record a capitalized lease liability of
Answers
A: $1,254,500 B: $1,352,000 C: $1,449,500 D: $1,547,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. Per SFAS 13, the lessee records as a liability the lower of the present value of the minimum lease payments (excluding executory costs), or the fair market value of the leased asset. Minimum lease payments for the lessee include the minimum rental payments and the amount of any bargain purchase option if exercise of the option appears reasonably assured. Since the fair market value of the leased asset is not given, the leased asset and lease obligation are recorded as the present value of the minimum lease payments, as computed below. Present value of annual rental $200,000 x 6.76 $1,352,000 Present value of bargain purchase option 97,500 $250,000 x .39 Present value of minimum lease payments $1,449,500 This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0037
Bond Company leased equipment from Howe, Inc. on December 31, 2007, for a 10-year period (the useful life of the asset) expiring December 30, 2017. Equal annual payments under the lease are $100,000 and are due on December 31 of each year. The first payment was made on December 31, 2007, and the second payment was made on the due
date. The present value at December 31, 2007, of the minimum lease payments over the lease term discounted at 10% (the implicit rate computed by Howe and known by Bond) was $676,000. Bonds incremental borrowing rate was 12% at December 31, 2007. The lease is appropriately accounted for as a capital lease by Bond. What should be the balance in Bonds liability under capital lease account at December 31, 2008?
Answers
A: $533,600 B: $545,120 C: $607,960 D: $800,000
Answer Explanations
A. Answer A is correct. The first payment (paid on the date the lease is signed) contains no interest and is, therefore, all reduction of principal. The second payment includes interest of $57,600 (10% x $576,000) and principal of $42,400 ($100,000 $57,600). Note that because Howe's implicit interest rate of 10% is known by Bond and is lower than Bond's incremental rate, it is used to compute the interest payment. Date 12/31/07 12/31/07 12/31/08 Cash payment $100,000 100,000 10% interest Reduction of principal $42,400 Lease liability $676,000 576,000 533,600
$57,600
Therefore, Bond should report a liability under capital lease as of 12/31/08 of $533,600. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0038
On December 30, 2007, Ames Co. leased equipment under a capital lease for 10 years. It contracted to pay $40,000 annual rent on December 31, 2007, and on December 31 of each of the next 9 years. The capital lease liability was recorded at $270,000 on December 30, 2007, before the first payment. The equipments useful life is 12 years, and the interest rate implicit in the lease is 10%. Ames uses the straight-line method to depreciate all equipment. In recording the December 31, 2008, payment, by what amount should Ames reduce the capital lease liability?
Answers
A: $27,000 B: $23,000 C: $22,500 D: $17,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. The initial lease obligation at 12/31/07 was $270,000. The first payment was made the same day, and therefore consisted entirely of principal reduction. After the payment, the lease obligation was $230,000 ($270,000 $40,000). The next lease payment, on 12/31/08, consists of both principal and interest. The interest portion is $23,000 ($230,000 x 10%), so the reduction in the lease liability is $17,000 ($40,000 $23,000).
Question: PVE-0039
On January 1, 2007, Vick Company as lessee signed a 10-year noncancelable lease for a machine stipulating annual payments of $20,000. The first payment was made on January 1, 2007. Vick appropriately treated this transaction as a capital lease. The 10 lease payments have a present value of $135,000 at January 1, 2007, based on implicit interest of 10%. For the year ended December 31, 2007, Vick should record interest expense of
Answers
A: $0 B: $ 6,500 C: $11,500 D: $13,500
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
C. Answer C is correct. At the inception of the lease on 1/1/07, the capitalized lease liability was $135,000. The first payment, also on 1/1/07, consisted entirely of principal and reduced the liability to $115,000 ($135,000 $20,000). Therefore, 2007 interest expense is $11,500 ($115,000 x 10%). This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0040
On January 1, 2007, Flip Corporation signed a 10-year noncancelable lease for certain machinery. The terms of the lease called for Flip to make annual payments of $30,000 for 10 years with title to pass to Flip at the end of this period. Accordingly, Flip accounted for this lease transaction as a capital lease of the machinery. The machinery has an estimated useful life of 15 years and no salvage value. Flip uses the straight-line method of depreciation for all of its fixed assets. The lease payments were determined to have a present value of $201,302 with an effective interest rate of 10%. With respect to this capitalized lease, Flip should record for 2007
Answers
A: Lease expense of $30,000. B: Interest expense of $16,580 and depreciation expense of $13,420. C: Interest expense of $20,130 and depreciation expense of $13,420. D: Interest expense of $13,420 and depreciation expense of $16,580.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. Per SFAS 13, a lessee's capital lease will incur interest expense. Interest expense, $20,130, is the carrying value of the lease obligation multiplied by the effective interest rate ($201,302 x 10%). Additionally, the cost of the equipment is depreciated over the life of the asset rather than the life of the lease since title automatically passes to the lessee at the end of 10 years the lessee will own the asset. Depreciation expense, $13,420, is the cost of the equipment depreciated over 15 years ($201,302/15 years). One difficulty with this question is whether there was a $30,000 payment on January 1, 2007. If so the interest expense would have been $17,130 [($201,302 $30,000 x 10%)]. There is no interest expense given in that amount. Therefore we must assume an ordinary annuity. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0041
Hines Company leased a new machine from Ashwood Company on December 31, 2007, under a lease with the following pertinent information: Lease term Annual rental payable at the beginning of each lease year Useful life of the machine Present value of the 8 lease payments at 12/31/07 8 years $ 50,000 10 years $258,000
The machine reverts to Ashwood at lease expiration date and has a fair value of $280,000 at the inception of the lease. Hines uses the straight-line method of depreciation. For the year ended December 31, 2008, how much depreciation (amortization) should Hines record for the capitalized leased machine?
Answers
A: $35,000 B: $32,250 C: $28,000 D: $25,800
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. Per SFAS 13, the lessee records the asset at the lower of (1) the present value of the minimum lease payments or (2) the fair market value of the leased asset. In this case, the present value ($258,000) is less than the fair market value ($280,000); therefore, $258,000 is capitalized. Since the machine reverts to the lessor at the end of the lease, the lessee should depreciate it over the lease term (8 years) even though it is less than the useful life (10 years). Depreciation expense is $32,250 ($258,000/8 years). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0042
In a sale-leaseback transaction, a gain resulting from the sale should be deferred at the time of the sale-leaseback and subsequently amortized when I. The seller-lessee has transferred substantially all the risks of ownership. II. The seller-lessee retains the right to substantially all of the remaining use of the property.
Answers
A: I only. B: II only. C: Both I and II. D: Neither I nor II.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. Per SFAS 28, in a sale-leaseback where the seller-lessee retains the right to substantially all of the remaining use of the property, a gain resulting from the sale should be deferred and subsequently amortized. On the other hand, when the seller-lessee has transferred substantially all the risks of ownership, any gain or loss on sale is recognized immediately. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0043
In a sale-leaseback transaction, the seller-lessee retains the right to substantially all of the remaining use of the equipment sold. The profit on the sale should be deferred and subsequently amortized by the lessee when the lease is classified as a(n) A. B. C. D. Capital lease No No Yes Yes Operating lease Yes No No Yes
Answers
A: A. B: B. C: C. D: D.
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. Per SFAS 28, any profit related to a sale-leaseback transaction in which the seller-lessee retains the right to substantially all of the remaining use of the equipment sold shall be deferred and amortized in proportion to the amortization of the leased asset if the transaction is classified as a capital lease. If the transaction is classified as an operating lease (e.g., if the lease begins in the last 25% of the asset's economic life), the profit shall be deferred and amortized in proportion to the related gross rental charged to expense over the lease term. It is important to note that losses are recognized immediately for either a capital or operating lease.
Question: PVE-0044
On December 31, 2007, Bain Corp. sold a machine to Ryan and simultaneously leased it back for 1 year. Pertinent information at this date follows: Sales price Carrying amount Present value of reasonable rentals ($3,000 for 12 months @ 12%) Estimated remaining useful life $360,000 330,000 34,100 12 years
In Bains December 31, 2007 balance sheet, the deferred revenue from the sale of this machine should be
Answers
A: $34,100 B: $30,000 C: $ 4,100 D: $0
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. D. Answer D is correct. SFAS 13 generally treats a sale-leaseback as a single financing transaction in which any profit on the sale is deferred and amortized by the seller. However, SFAS 28 amends this general rule when either only a minor part of the remaining use of the leased asset is retained (case 1), or when more than a minor part but less than substantially all of the remaining use of the leased asset is retained (case 2). Case 1 occurs when the PV of the lease payments is 10% or less of the FMV of the saleleaseback property. Case 2 occurs when the leaseback is more than minor but does not
meet the criteria of a capital lease. This is an example of case 1, because the PV of the lease payments ($34,100) is equal to or less than 10% of the FMV of the asset ($360,000). SFAS 28 specifies that under these circumstances, the full gain ($360,000 $330,000 = $30,000) is recognized , and none is deferred.
Question: PVE-0045
On January 1, 2007, Hooks Oil Co. sold equipment with a carrying amount of $100,000, and a remaining useful life of 10 years, to Maco Drilling for $150,000. Hooks immediately leased the equipment back under a 10-year capital lease with a present value of $150,000 and will depreciate the equipment using the straight-line method. Hooks made the first annual lease payment of $24,412 in December 2007. In Hooks December 31, 2007 balance sheet, the unearned gain on equipment sale should be
Answers
A: $50,000 B: $45,000 C: $25,588 D: $0
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. B. Answer B is correct. According to SFAS 13, sale-leaseback transactions are treated as though two transactions were a single financing transaction, if the lease qualifies as a capital lease. Any gain on the sale is deferred and amortized over the lease term (if possession reverts to the lessor) or the economic life (if ownership transfers to the lessee). Since this is a capital lease, the entire gain ($150,000 $100,000 = $50,000) is deferred at 1/1/07. At 12/31/07 an adjusting entry must be prepared to amortize 1/10 of the unearned gain (1/10 x $50,000 = $5,000), because the lease covers 10 years. Therefore, the unearned gain at 12/31/07 is $45,000 ($50,000 $5,000). This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0046
Conn Company purchased a new machine for $480,000 on January 1, 2007, and leased it to East the same day. The machine has an estimated 12-year life, and will be depreciated $40,000 per year. The lease is for a 3-year period expiring January 1, 2010, at an annual rental of $85,000. Additionally, East paid $30,000 to Conn as a lease bonus to obtain the 3-year lease. For 2007 Conn incurred insurance expense of $8,000 for the leased machine. What is Conns 2007 operating profit on this leased asset?
Answers
A: $67,000 B: $55,000 C: $47,000 D: $37,000
Answer Explanations
This answer is incorrect. Refer to the correct answer explanation. This answer is incorrect. Refer to the correct answer explanation. C. Answer C is correct. This lease is an operating lease because it does not meet any of the four criteria to be a capital lease as described in SFAS 13. The lessor (Conn) should recognize as revenue the 2007 rental payment ($85,000) plus a proportionate fraction of the lease bonus ($30,000/ 3-year lease term = $10,000 per year). Therefore, total revenue for 2007 is $95,000 ($85,000 + $10,000). 2007 expenses total $48,000 (depreciation of $40,000 and insurance of $8,000). Thus, operating profit on the leased asset is $47,000 ($95,000 revenues less $48,000 expenses). This answer is incorrect. Refer to the correct answer explanation.
Question: PVE-0047
Connor Corporation signed a lease on January 1, 2005, to rent equipment for 10 years. The lease was appropriately treated as a capital lease. On January 1, 2008, Connor renegotiated the lease terms. The new lease agreement does not contain a bargain purchase option, nor transfer of title. The new lease terms are for a shorter length of time, which is not greater than 75% of the economic useful life of the asset. The present value of the minimum lease payments under the new agreement is less than 90% of the fair market value of the leased asset. How should Connor account for the change in the lease agreement?
Answers
A: Reduce the leased asset account by the gross value in the reduction of payments. B: Remove the leased asset from the books and treat the lease as an operating lease. C: Make no change until the end of the lease term at which time a gain or loss will be recognized for the reduction in payments. D: Treat the new lease as a sales-leaseback.
Answer Explanations
D. Answer D is correct. SFAS 145, para 4 amended SFAS 13. This amendment requires that capital leases that are modified so that the resulting lease agreement is classified as an operating lease be accounted for under the sale-leaseback provisions of FASB Statement 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate; Sales-Type Leases of Real Estate; Definition of the Lease Term; Initial Direct Costs of Direct Financing Leases, or paragraphs 2 and 3 of FASB Statement 28, Accounting for Sales with Leasebacks, as applicable.
Question: PVE-0048
Dahlia, Inc. signed a lease to rent equipment on July 1, 2006. On January 1, 2008, Dahlia decides that the equipment is no longer needed, and the company pays a $20,000 penalty to cancel the lease. How should the cancellation be reported on Dahlias financial statements?
Answers
A: Recognize the cost of termination at the fair value at the date the agreement is terminated. B: Compare the termination costs to the present value of avoidable lease payments and recognize the difference as a loss at the date the equipment ceases to be used. C: Defer recognition of the loss until the end of the normal lease term. D: Amortize the loss over the remaining term of the lease.
Answer Explanations
A. Answer A is correct. Per SFAS 146, Dahlia should recognize the termination costs at fair value at the date the agreement is terminated, the entity no longer receives the rights to the assets, or the company ceases to use the asset (cease-use date).
Question: PVE-0049
Dahlia, Inc. signed a lease to rent equipment on July 1, 2006. On January 1, 2008, Dahlia decides that the equipment is no longer needed, and the company pays a $20,000 penalty
to cancel the lease. How should the cost of termination be disclosed on Dahlias income statement?
Answers
A: Recognize the cost of termination as a discontinued operation net of tax. B: Recognize the cost of termination as an extraordinary item net of tax. C: Recognize the cost of termination as a component of other comprehensive income. D: Recognize the cost of termination as a part of income from continuing operations.
Answer Explanations
D. Answer D is correct. Per SFAS 146, termination costs of an operating lease are included in calculating income from continuing operations. If the termination of a lease is associated with the exit or disposal of a discontinued operation, these costs are included in the results of discontinued operations. (See outline of SFAS 146).
Question: PVE-0050
Green Co. incurred leasehold improvement costs for its leased property. The estimated useful life of the improvements was 15 years. The remaining term of the nonrenewable lease was 20 years. These costs should be
Answers
A: Expensed as incurred. B: Capitalized and depreciated over 20 years. C: Capitalized and expensed in the year in which the lease expires. D: Capitalized and depreciated over 15 years.
Answer Explanations
Null Null Null
D. Answer D is correct. The requirement is to identify how leasehold improvement costs should be treated. Leasehold improvements should be depreciated over the
remaining useful life of the leasehold improvement or the remaining life of the lease, whichever is shorter. Therefore, the leasehold improvement should be capitalized and depreciated over 15 years, and answer D is correct.
Question: PVE-0051
Which of the following is a criterion for a lease to be classified as a capital lease in the books of a lessee?
Answers
A: The lease contains a bargain purchase option. B: The lease does not transfer ownership of the property to the lessee. C: The lease term is equal to 65% or more of the estimated useful life of the leased property. D: The present value of the minimum lease payments is 70% or more of the fair market value of the leased property.
Answer Explanations
A. Answer A is correct. The requirement is to identify the criterion for a lease to be classified as a capital lease. According to FAS 13, answer A is correct because if the lease contains a bargain purchase option, it must be classified as a capital lease. B. Answer B is incorrect because a capital lease will transfer ownership of the property to the lessee. C. Answer C is incorrect because the lease term is equal to 75% or more of the estimated useful life of the asset. D. Answer D is incorrect because the present value of the minimum lease payments must be 90% or more of the fair market value of the leased property.
Question: PVE-0052
Koby Co. entered into a capital lease with a vendor for equipment on January 2 for seven years. The equipment has no guaranteed residual value. The lease required Koby to pay $500,000 annually on January 2, beginning with the current year. The present value of an annuity due for seven years was 5.35 at the inception of the lease. What amount should Koby capitalize as leased equipment?
Answers
A: $ 500,000
B: $ 825,000 C: $2,675,000 D: $3,500,000
Answer Explanations
Null Null
C. Answer C is correct. The requirement is to determine the amount of the capitalized value of the leased equipment. The equipment should be capitalized as the present value of the minimum lease payments. The present value of the minimum lease payments at January 2 is calculated as the present value of the annuity due factor times the payment, or $2,675,000 (5.35 $500,000).
Null