Question

1. Why has accounting for leases been controversial?

a) Leasing is uncommon.

b) Companies have structured leases in a way that the lease liabilities remain “off-balance sheet”.

c) All leases are structured the same way and treated the same way.

d) Most leases are immaterial.

2. Accounting for leases is important to all EXCEPT the following: a) U.S. Congress.

b) leasing companies.

c) financial institutions.

d) companies who purchase assets outright.

3. An essential element in a lease agreement is that the

a) lessee transfers less than the total interest in the property.

b) lessor transfers less than the total interest in the property.

c) lease must contain a bargain purchase option.

d) rental (lease) payments must be constant for the duration of the lease.

4. Executory costs include

a) maintenance, interest and property taxes. b) interest, property taxes and depreciation.

c) insurance, maintenance and property taxes. d) maintenance, insurance and income taxes.

5. Which of the following is NOT a potential advantage of leasing? a) no tax advantages for the lessor

b) cheaper financing

c) 100% financing at fixed rates

d) protection against obsolescence

6. A sale-leaseback transaction is

a) a lease that has a profit component that is recognized as sales revenue.

b) when a company buys an asset and then leases it to someone else other than the seller.

c) a transaction in which a property owner sells a property to another party and, and at the same time leases a similar asset.

d) a transaction in which a property owner sells a property to another party and, at the same time, leases the same asset back from the new owner.

7. Madrigal Corp. sold its headquarters building at a gain, and simultaneously leased back the building from the buyer. The lease was reported as a capital (finance) lease. At the time of the sale, the gain should be reported as

a) operating income.

b) other comprehensive income.

c) a separate component of shareholders' equity. d) a deferred gain.

8. Under ASPE, if land is the sole property being leased, and title does NOT transfer at the end of the lease, it should be accounted for as a(n)

a) operating lease.

b) capital lease.

c) sales-type lease.

d) direct-financing lease.

9. Under IFRS, if land is the sole property being leased, and title does transfer at the end of the lease, it should be accounted for as a(n)

a) operating lease.

b) capital lease.

c) sales-type lease or financing lease. d) rental agreement.

10. Under IAS 17 when should a company classify its leases as finance leases?

a) when the risks and rewards of ownership are transferred to the lessee

b) all leases are finance leases

c) all leases are finance leases except for leases of low-value assets and short-term leases d) when it is a sale-leaseback lease

11. On January 1, 2017, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of

$271,622 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2017, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

3. Marlene depreciates all its machinery on a straight-line basis.

4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8% implicit rate used by Dietrich.

5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful.

From Marlene’s viewpoint, what type of lease is this? a) operating lease

b) finance lease

c) manufacturer or dealer lease

d) other finance lease

12. Assume Sunny Corp. (a company reporting under IFRS) wants to earn an 8% return on its investment of $1,200,000 in an asset that is to be leased to Cloudy Corp. for ten years with an annual rental due in advance each year. How much should Sunny charge for annual rental assuming there is no purchase option that is reasonably certain to be exercised by Cloudy Corp.?

a) $120,000 b) $165,588 c) $178,835 d) $216,000

13. On January 1, 2017, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectibility of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

1. The agreement requires equal payments at the end of each year.

2. At January 1, 2017, the fair value of the building is $900,000 and Seline’s book value is $750,000.

3. The building has an estimated economic life of 10 years, with no residual value. Dionne uses straight-line depreciation for all its depreciable assets.

4. At the termination of the lease, title to the building will transfer to the lessee.

5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a

10% rate of return. The lessor’s implicit rate is known to Dionne.

6. The yearly lease payment includes $3,000 executory costs related to taxes on the property.

Rounded to the nearest dollar, how much depreciation expense would Dionne record on this asset for calendar 2017?

a) $0

b) $75,000 c) $90,000 d) $146,471

14. On July 1, 2017, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2017. Justin had purchased the equipment for $390,000 on January 1, 2017, and established a selling price of $500,000 (which was fair value at July 1, 2017). Assume that, at July 1, 2017, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years.

For the year ended December 31, 2017, and assuming that Trudeau uses straight-line depreciation, how much depreciation and interest expense should Trudeau record?

a) $18,750 and $15,516

b) $18,750 and $24,840

c) $22,500 and $15,516 d) $22,500 and $24,840

15. On January 1, 2017, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of

$271,622 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2017, is $700,000. The machine has a

remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

3. Marlene depreciates all its machinery on a straight-line basis.

4. Marlene's incremental borrowing rate is 10%. Marlene does not have knowledge of the 8%

implicit rate used by Dietrich.

5. Immediately after signing the lease, Dietrich discovers that Marlene is the defendant in a lawsuit that is sufficiently material to make collectibility of future lease payments doubtful.

Assume the present value of the lease payments is $700,000 at January 1, 2017.

If Marlene accounts for this lease as a finance lease, what is the amount of the reduction in the lease obligation in calendar 2018? (Round to the nearest dollar.)

a) $201,622

b) $215,622

c) $221,784 d) $232,873

Use the following information for questions 16–17.

On January 2, 2017, Cambridge Ltd. signed a ten-year non-cancellable lease for a heavy-duty drill press. The lease required annual payments of $35,000, starting December 31, 2017, with title passing to Cambridge at the end of the lease. Cambridge is accounting for this lease as a capital (finance) lease. The drill press has an estimated useful life of 20 years, with no residual value. Cambridge uses straight-line depreciation for all its plant assets. The lease payments were determined to have a present value of $215,000, based on an implicit interest rate of 10%.

16. On their 2017 income statement, how much interest expense should Cambridge report in connection with this lease?

a) $0

b) $13,125

c) $17,500 d) $21,500

17. On their 2017 income statement, how much depreciation expense should Cambridge report in connection with this lease?

a) $10,750

b) $17,500

c) $21,500 d) $35,000

18. On December 31, 2017, Eastern Inc. leased machinery with a fair value of $420,000 from Northern Rentals. The agreement is a six-year non-cancellable lease requiring annual payments of $80,000 beginning December 31, 2017. The lease is appropriately accounted for by Eastern as a finance lease. Eastern’s incremental borrowing rate is 11%; however, they also know that the interest rate implicit in the lease payments is 10%. Eastern adheres to IFRS.

The present value of an annuity due for 6 years at 10% is 4.7908.

The present value of an annuity due for 6 years at 11% is 4.6959.

On its December 31, 2017 statement of financial position, Eastern should report a lease liability of (rounded to the nearest dollar)

a) $303,264.

b) $340,000.

c) $375,672.

d) $383,264.

19. Frank Corporation has an asset with a fair market value of $200,000 that it wants to lease. Frank’s wants to recover its net investment in the leased asset and earn a 10% return. The asset will revert back to Frank’s at the end of a 6-year lease term. If Frank’s charges rent annually at the beginning of the year, what should amount should the annual rent be (rounded to whole dollars)?

a) $18,817

b) $33,333 c) $41,747 d) $53,333

20. Rabbit Inc. has an asset with a fair market value of $450,000 that it wants to lease. Rabbit’s wants to recover its net investment in the leased asset and earn an 8%. The asset will revert back to Rabbit’s at the end of a 5-year lease term and it is expected that the residual value of the asset will be $20,000 at the end of the lease. If Rabbit wants to charge rent semi-annually starting at the beginning of the lease, what amount should the lease payments be (rounded to whole dollars)?

a) $60,817 b) $62,096 c) $101,200 d) $104,367

Answer 1

1. Why has accounting for leases been controversial?
a) Leasing is uncommon.
b) Companies have structured leases in a way that the lease liabilities remain “off-balance sheet”.	Correct	From an accounting standpoint, leases have been controversial because many leases are "off-balance sheet"
c) All leases are structured the same way and treated the same way.
d) Most leases are immaterial.
2. Accounting for leases is important to all EXCEPT the following:
a) U.S. Congress	Correct	Lease is the cost-effective way of financing property and equipment
b) leasing companies.
c) financial institutions.
d) companies who purchase assets outright.
3. An essential element in a lease agreement is that the
a) lessee transfers less than the total interest in the property.
b) lessor transfers less than the total interest in the property.
c) lease must contain a bargain purchase option.
d) rental (lease) payments must be constant for the duration of the lease.	Correct	The lease specifies also the duration of the lease and rental payments
4. Executory costs include
a) maintenance, interest and property taxes.
b) interest, property taxes and depreciation.
c) insurance, maintenance and property taxes.	correct	The obligations for taxes, insurance, and maintenance  are executory costs that may be assumed by the lessor or the lessee or divided among themselves
d) maintenance, insurance and income taxes.
5. Which of the following is NOT a potential advantage of leasing?
a) no tax advantages for the lessor	Correct	The tax benefit is availed to both the parties Lessor and Lessee. Lessor,  can claim depreciation as an expense in his books and therefore get the tax benefit. On the other hand, the lessee can claim  lease rentals as an expense and achieve tax benefit in a similar way.
b) cheaper financing
c) 100% financing at fixed rates
d) protection against obsolescence
6. A sale-leaseback transaction is
a) a lease that has a profit component that is recognized as sales revenue.
b) when a company buys an asset and then leases it to someone else other than the seller.
c) a transaction in which a property owner sells a property to another party and, and at the same time leases a similar asset.	Correct