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Exam 15: Leases

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Question 1

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Which of the following is true regarding the deferral of sale profits on a sale-leaseback under IAS 17, "Accounting for Leases?

A) Any profit on a sale-leaseback resulting in an operating lease is deferred and recognized over the subsequent lease period, whereas any loss is recognized immediately.
B) Both profits and losses on a sale followed by an operating lease leaseback are recognized immediately if the transaction is established at fair value.
C) Profit from the sale should be deferred and amortized in proportion to the amortization of the leased asset if a capital lease results from the sale-leaseback.
D) Profit from the sale should be amortized in proportion to the rental payments it an operating lease results from the sale-leaseback.

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Question 2

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Johntech Inc. leased a new machine having an expected useful life of 30 years from Carbide Co. Terms of the noncancelable 25-year lease were that Johntech would gain title to the property upon payment of a sum equal to the fair market value of the machine at the termination of the lease. Johntech accounted for the lease as a capital lease and recorded an asset and a liability in the financial records. The asset recorded under this lease should properly be amortized over

A) 5 years (the period of actual ownership) .
B) 22.5 years (75 percent of the 30-year asset life) .
C) 25 years (the term of the lease) .
D) 30 years (the total asset life) .

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Question 3

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Which of the following statements characterizes an operating lease?

In a lease that is recorded as a direct financing lease by the lessor, unearned revenue

George Harmon is the president of the Utah Western Railroad Company. The Utah Western is a bridge line that receives traffic from the Union Pacific Railroad and the Burlington Northern railroads at Salt Lake City, Utah, and hauls the freight to Denver, Colorado, for connections with other lines to points east. Recently, traffic on the Utah Western has increased dramatically and the railroad is in need of additional locomotives to haul its trains. Accordingly, George is considering leasing locomotives to meet the demands of this increase in traffic until new engines can be ordered if the surge subsides. As the controller of the railroad, George has asked you to advise him as to the disadvantages associated with leasing generally.

The lessor capitalizes and amortizes initial direct costs for all types of leases except

Which of the following is not a required disclosure for lessors?

Which of the following statements concerning guaranteed residual values is appropriate for the lessee?

Spartan Corporation has entered into a debt agreement that restricts its debt-to-equity ratio to less than two-to-one. The corporation is planning to expand its facilities, creating a need for additional financing. The board of directors is considering leasing the additional facilities but is concerned that leasing may violate its existing debt agreement. A violation of the debt agreement would place the corporation in default. The potential lessor insists that the lease be structured in such a way that it can be accounted for as a capital lease by the lessor (the lessor is a dealer and wants to recognized the dealer's gross profit on the transaction immediately). In addition, the lessor requires that the residual value of the leased asset be guaranteed when it reverts to the lessor at the end of the lease term. Spartan's board has asked you to analyze the following alternative: Alternative 1--Spartan would enter into a lease that qualifies as a capital lease (to Spartan). If this alternative is selected, Spartan's reported debt-to-owners'-equity ratio would be 1.9, and its ability to issue debt in the future would be seriously constrained. Alternative 2--Spartan would enter into a lease and pay a third party to guarantee the residual value of the leased property. The lease would be structured in such a way as to qualify as an operating lease to Spartan and as a capital lease to the lessor. In this case, Spartan's reported debt-to-equity ratio would be unaffected by the lease contract. Required: Explain the consequences of each of these alternatives, including any ethical considerations that might exist.

Generally accepted accounting principles require that certain lease agreements be accounted for as purchases. The theoretical basis for this treatment is that a lease of this type

On December 31, 2011, Gephardt Enterprises leased equipment from B & B Equipment Rental. Pertinent lease transaction data are as follows: Gephardt should record the equipment on the books at

Johnson Institute leased a new machine having an expected useful life of 12 years. The noncancelable lease term is 10 years, and Johnson may exercise a purchase option at the end of the noncancelable term. The machine should be capitalized by Johnson and depreciated over

Lofgreen Company leased an asset for use in its factory. The lease agreement specifies that Lofgreen is to make annual payments of $2,818 payable at the end of each year. The lessor classified the lease as a direct-financing lease since Lofgreen was allowed to lease the asset at its cost of $14,000 (the present value of the lease payments) . The lessor receives a 12 percent rate of return on the lease. The estimated residual value at the end of the lease term is zero. If the lease was classified as a capital lease by Lofgreen, how much annual depreciation would Lofgreen record using the straight-line method?

In a lease that is recorded as an operating lease by the lessee, the equal monthly rental payments should be

On January 1, 2011, Larsen Corporation sold a machine to Parson Corporation and simultaneously leased it back for ten years. The following information is available regarding the lease: How much profit should Larsen recognize on January 1, 2011, on the sale of the machine?

GW Company operates a large regional railway system. The following is an excerpt from the company's 2010 annual report: 6. Lease Commitments GW is committed under long-term lease agreements, which expire on various dates through 2082, for equipment, rail lines, and other property. Future minimum lease payments are as follows: Required: Given that lease payments occur evenly throughout the year, estimate the decline in the capital lease liability in 2010.

Lease Y 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 Z 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 Y Lease Z

Business leasing has become a large market. Banks, other lending institutions, and commercial leasing companies represent the largest share of the business leasing market with the remainder consisting of manufacturers, dealers, and distributors. Identify the advantages and disadvantages to lessors of leasing rather than selling property.

On January 1, Twix Company as lessee signed a ten-year noncancelable lease for a machine with annual payments of $60,000. The first payment was also made on January 1. Twix appropriately treated this transaction as a capital lease. The ten lease payments have a present value of $405,000 at January 1, based on implicit interest of 10 percent. For the first year, Twix should record interest expense of

Johnson, Inc., leased an asset to Raymond Corporation. The cost of the asset to Johnson was $8,000. Terms of the lease specify four-year life for the lease, an annual interest rate of 15 percent, and four year-end rental payments. The lease qualifies as a capital lease and is classified as a direct-financing lease. The asset reverts to Johnson after the fourth year, when its residual value is estimated to be $1,000. The amount of each rental payment is