Accounting For Leases Quiz Questions

Executory costs refer to ongoing expenses that are incurred to maintain and operate a property or asset. These costs include maintenance, property taxes, and insurance. The correct answer, option d, states that all of these costs are included in executory costs. Therefore, the correct answer is d.

The major reasons why a company may become involved in leasing to other companies are interest revenue, high residual values, and tax incentives. Leasing allows the company to earn interest revenue by charging a lease fee to the lessee. Additionally, leasing assets with high residual values can be profitable for the company as they can sell the assets at a higher price after the lease period ends. Lastly, there may be tax incentives available for companies that engage in leasing activities, providing further financial benefits.

Leasing offers several advantages including off-balance-sheet financing, which means that the leased assets do not appear on the lessee's balance sheet. This can be beneficial for companies looking to maintain a strong balance sheet or avoid certain financial ratios. Leasing can also be less costly compared to purchasing, as it does not require a large upfront payment. Additionally, leasing often provides 100% financing at fixed rates, allowing businesses to acquire assets without having to make a significant initial investment or worry about interest rate fluctuations. Therefore, the correct answer is d. All of these.

The lease liability account represents the amount of money that a company owes for its lease obligations. Since lease obligations can have both short-term and long-term portions, it is appropriate to disclose the current portion of the lease liability in current liabilities, as it is expected to be settled within the next year. The remainder of the lease liability, which represents the long-term portion, should be disclosed in noncurrent liabilities, as it is not expected to be settled within the next year. This ensures that the financial statements accurately reflect the timing of the company's lease payment obligations.

The correct answer is a. operating and capital lease methods. This is because the lessee can choose to account for a lease as either an operating lease or a capital lease. In an operating lease, the lessee records the lease payments as an expense on the income statement. In a capital lease, the lessee records the leased asset as an asset on the balance sheet and recognizes both an asset and a liability. Therefore, the lessee has the option to choose between these two methods based on the nature of the lease agreement.

The correct answer is d. any of these. This means that the minimum lease payments can include a penalty for failure to renew, a bargain purchase option, or a guaranteed residual value. In other words, any or all of these options can be included in the minimum lease payments.

The correct answer is d. All of these. This means that all of the statements mentioned in options a, b, and c are correct. In a direct-financing lease, initial direct costs are added to the net investment in the lease. In a sales-type lease, initial direct costs are expensed in the year of incurrence. And for operating leases, initial direct costs are deferred and allocated over the lease term. Therefore, all of these statements are correct.

In a lease that is appropriately recorded as a direct-financing lease by the lessor, unearned income should be amortized over the period of the lease using the effective interest method. This method calculates interest expense based on the carrying amount of the lease receivable and the effective interest rate. By using this method, the lessor recognizes interest income over the lease term in a way that reflects the pattern of the lease payments and the time value of money. This ensures a more accurate and appropriate allocation of income over the lease period.

The primary difference between a direct-financing lease and a sales-type lease is the recognition of the manufacturer's or dealer's profit at the inception of the lease. In a sales-type lease, the lessor recognizes profit at the beginning of the lease because it is considered a sale of the leased asset. On the other hand, in a direct-financing lease, the lessor does not recognize profit at the inception of the lease as it is considered a financing arrangement. The lessor only recognizes interest income over the lease term.

The correct statement of one of the capitalization criteria is that the lease term is equal to or more than 75% of the estimated economic life of the leased property. This means that if the lease term is at least 75% of the estimated economic life of the property, then the lease should be capitalized and recorded as an asset on the balance sheet.

In computing depreciation of a leased asset, the lessee should subtract a guaranteed residual value and depreciate over the term of the lease. This means that the lessee can subtract the guaranteed residual value, which is the estimated value of the asset at the end of the lease term, from the initial cost of the asset. The remaining value is then depreciated evenly over the term of the lease. This method allows the lessee to account for the expected value of the asset at the end of the lease and accurately calculate the depreciation expense over the lease term.

The lease receivable in a direct-financing lease is defined as the present value of minimum lease payments. This means that the lessor calculates the value of the lease based on the present value of the future cash flows they expect to receive from the lessee. This method takes into account the time value of money and provides a more accurate representation of the value of the lease. The other options do not accurately define the lease receivable in a direct-financing lease.

The lessee should use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. This is because the present value of the minimum lease payments should be calculated using the discount rate that reflects the lessee's cost of borrowing. If the lessee's incremental borrowing rate is lower than the implicit rate of the lessor, it would be more cost-effective for the lessee to use its own borrowing rate. However, if the implicit rate of the lessor is lower, it would be more advantageous for the lessee to use that rate instead.

The Lease Receivable account is used to record the amount of money that a lessor expects to receive from a lessee over the term of a lease. It includes the guaranteed residual value, which is the amount the lessor expects to receive from the lessee at the end of the lease term. It also includes the unguaranteed residual value, which is the amount that the lessor expects to receive from the lessee if the leased asset is sold at the end of the lease term. Additionally, it includes a bargain purchase option, which is an option for the lessee to purchase the leased asset at a price significantly below its fair value. Therefore, all of these items would be included in the Lease Receivable account.

When a company sells property and then leases it back, any gain on the sale should usually be deferred and recognized as income over the term of the lease. This is because the company no longer owns the property but still benefits from its use through the lease agreement. Recognizing the gain immediately would not accurately reflect the economic reality of the transaction. Instead, the gain is spread out over the term of the lease, matching the recognition of income with the company's ongoing benefit from the property.

The correct answer is b. Leases similar to installment purchases are capitalized. This means that leases that are similar to installment purchases, where the lessee has the benefits and risks of ownership, are treated as capital leases and are recorded on the balance sheet as assets and liabilities. This is in accordance with the current practice in accounting for leases, as outlined in the Financial Accounting Standards Board (FASB) guidelines. Leases that do not meet the criteria for capital leases are treated as operating leases and are not capitalized.

If the residual value of a leased asset is guaranteed by a third party, it means that the third party has agreed to pay the residual value if the lessee is unable to do so. In this case, the lessee treats the guaranteed residual value as an additional payment, meaning that they consider it as part of their lease obligations. On the other hand, the lessor treats the guaranteed residual value as realized at the end of the lease term, meaning that they consider it as income received. This is because the lessor can rely on the third party to fulfill the residual value obligation, reducing the risk for the lessor.

In the earlier years of a lease, from the lessee's perspective, the use of the capital method will cause debt to increase, compared to the operating method. This is because the capital method requires the lessee to record the lease as a liability on their balance sheet, which increases their overall debt. On the other hand, the operating method does not require the lessee to record the lease as a liability, resulting in lower debt. Therefore, choosing the capital method will lead to higher debt for the lessee.

When a lessee has a capital lease with a bargain purchase option, it means that the lessee has the option to purchase the asset at a price significantly lower than its fair market value at the end of the lease term. In this case, the lessee is essentially expected to exercise the bargain purchase option, and therefore, the leased asset is considered to have a remaining economic life beyond the lease term. Therefore, the lessee should depreciate the leased asset over its remaining economic life, rather than the term of the lease.

When lessors account for residual values related to leased assets, they always include the residual value because they always assume that the residual value will be realized. This means that they expect to receive the residual value at the end of the lease term. Including the residual value in the accounting allows them to accurately reflect the expected future cash flows from the lease.

In a sales-type lease, the gross profit is the difference between the sales price and the cost of goods sold. The sales price includes the present value of the unguaranteed residual value, which is the estimated value of the leased asset at the end of the lease term. However, the present value of the guaranteed residual value is not deducted to determine the cost of goods sold. Therefore, the gross profit will be the same regardless of whether the residual value is guaranteed or unguaranteed.

If a lease agreement includes a bargain purchase option, it means that the lessee has the option to purchase the asset at a price significantly lower than its fair value at the end of the lease term. In this case, the lessee must increase the present value of the minimum lease payments by the present value of the option price. This is because the inclusion of the bargain purchase option increases the total cost of the lease for the lessee, as they have the potential to acquire the asset at a discounted price. Therefore, the present value of the minimum lease payments needs to account for this additional cost.

Under a capital lease, the lessee records the asset as a long-term asset and the corresponding liability for the present value of the minimum lease payments. The amount to be recorded as the cost of the asset is determined by taking the present value of the minimum lease payments or the fair value of the asset, whichever is lower. This is because the lessee should record the asset at the lower of the two amounts in order to properly reflect the economic substance of the transaction.

In a sales-type lease with an unguaranteed residual value, the lessor recognizes sales revenue in the period of inception of the lease. The amount of sales revenue recognized is the present value of the minimum lease payments. This is because the lessor is essentially selling the asset to the lessee and is entitled to recognize revenue based on the present value of the lease payments they will receive over the lease term. The unguaranteed residual value does not factor into the calculation of sales revenue, as it is not guaranteed to the lessor. Therefore, the correct answer is b. The present value of the minimum lease payments.

Companies can avoid leased asset capitalization by using a higher interest rate than that used by the lessor, setting the lease term at less than 75% of the estimated useful life of the property, or using a third party to guarantee the asset's residual value. However, writing in a bargain purchase option does not help in avoiding leased asset capitalization.

The correct answer is c. A lease reflects the purchase or sale of a quantifiable right to the use of property. This is because a lease represents a contractual agreement between the lessor (owner) and the lessee (user) where the lessee pays for the right to use the property for a specific period of time. This right to use the property can be quantified in terms of the duration of the lease and any specific terms or conditions outlined in the agreement. Therefore, considering all leases as sales or purchases is justified based on the quantifiable nature of the right to use the property.

In a lease conveyance, the lessor (property owner) transfers the right to use the property to the lessee (tenant) for a specified period of time. However, the lessor does not transfer their entire interest in the property. This means that the lessor retains some ownership rights and control over the property, even though they have granted the lessee the right to use it. This is an essential element of a lease conveyance, as it distinguishes it from a sale or transfer of full ownership.

In a sale-leaseback transaction where none of the four leasing criteria are satisfied, the purchaser-lessor does not record a gain. In a sale-leaseback transaction, a gain is typically recorded by the seller-lessee, not the purchaser-lessor. Therefore, option b is false. The other options are true: the seller-lessee removes the asset from its books, and the seller-lessee records the lease as an operating lease.

The correct answer is c. "are expensed in the period of the sale under a sales-type lease." This means that the initial direct costs of leasing, such as costs related to internal activities and costs paid to external third parties, are recognized as expenses in the period when the lease agreement is made under a sales-type lease. This is different from options a and b, which do not accurately describe the treatment of initial direct costs in leasing. Option d is incorrect because not all of the statements are true, only option c is true.