CHAPTER 21

ACCOUNTING FOR LEASES

TRUE-FALSEConceptual
Answe
T F F T F F T F F T F F T F T F T F T T

No!
1. 2. 3. 4. 5. #. %. &. ). 1+. 11. 12. 13. 14. 15. 1#. 1%. 1&. 1). 2+.

"esc #pt#on
Benefits of leasing. Accounting for long-term leases. Classifying lease containing purchase option. Accounting for executory costs. epreciating a capitali!e" asset. $essee recor"ing of interest expense. Benefit of leasing to lessor. istinction 'et(een "irect-financing an" sales-type leases. $essors* classification of leases. irect-financing leases. Accounting for operating lease. Computing annual lease payments. ,uarantee" resi"ual -alue "efinition. ,uarantee" -s. unguarantee" resi"ual -alue. .nguarantee" resi"ual -alue an" minimum lease payments. /et in-estment an" guarantee"0unguarantee" resi"ual -alue. ifference 'et(een "irect-financing an" sales-type leases. ,ross profit in sales-type lease. 1e-ie( of estimate" unguarantee" resi"ual -alue. FA2B re3uire" lease "isclosures.

$ULTIPLE CHOICEConceptual
Answe
" " ' c a ' ' a c " " c a ' a a " a

No!
21. 22. 23. 24. 2 25. 2 2#. 5 2%. 2&. 2). 3+. 31. 32. 33. 34. 5 35. 3#. 3%. 3&.

"esc #pt#on
A"-antages of leasing. A"-antages of leasing. Basic principle of lease accounting. Conceptual support for treating all leases as a sale0purchase. 4ssential element of a lease. Bargain purchase option an" minimum lease payments. Cost amount for a capital lease. $ease accounting 'y lessee. 6no(le"ge of the capitali!ation criteria. Components of minimum lease payments. 7"entification of executory costs. iscount rate use" 'y lessee. epreciation of a lease" asset 'y lessee. 4ffect of a capital lease on lessee8s "e't. epreciation of a capital lease. 7"entification of lease type for lessor. 4lements of lease recei-a'le 'y lessor. 1ecognition of unearne" lease income.

21 - 2 c

Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

2

3).

irect-financing lease recei-a'le.

$ULTIPLE CHOICEConceptual -cont!.

Answe
" c ' c " c "
5 2

No!
2

"esc #pt#on
Thir" party guarantee of resi"ual -alue. ifference 'et(een "irect financing an" sales-type lease. Amount of re-enue in sales-type lease. Accounting for a sales-type lease. Accounting for initial "irect costs. isclosing o'ligations un"er capital leases. ,ain0loss recognition in a sale-lease'ac:.

4+. 2 41. 5 42. 43. 44. 45. 94#.

These 3uestions also appear in the 5ro'lem-2ol-ing 2ur-i-al ,ui"e. These 3uestions also appear in the 2tu"y ,ui"e. 9This topic is "ealt (ith in an Appen"ix to the chapter.

$ULTIPLE CHOICECo(putat#onal
Answe
' c c " a c c " c c a ' " c c " ' ' c a c " a " a ' c c c a ' c

No!
4%. 4&. 4). 5+. 51. 52. 53. 54. 55. 5#. 5%. 5&. 5). #+. #1. #2. #3. #4. #5. ##. #%. #&. #). %+. %1. %2. %3. %4. %5. %#. %%. %&.

"esc #pt#on
;perating lease expense for year. Calculate interest expense an" "epreciation expense for lessee. Calculate minimum annual lease payment. Calculate total annual lease payment. 7"entification of lease type for lessor. 7"entification of lease type for lessee. Calculate "epreciation expense for lessee. 7"entification of lease type for lessee. Calculate lease" asset amount. Calculate total lease o'ligation. Compute interest expense for year. Compute interest expense for year. Calculate lease lia'ility amount. Compute interest expense an" "epreciation expense for year. Compute interest expense an" "epreciation expense for year. Compute "epreciation expense for lease (ith transfer of title. 7"entification of lease type for lessee. 4xpense recor"e" 'y lessee0operating lease. Calculate re"uction of lease o'ligation for lessee. 7"entification of lease type for lessor. Calculate lease recei-a'le. 1e-enues an" expenses recor"e" 'y lessor0operating lease. ;perating lease expense for year. Calculate expense of an operating lease. Calculate income from operating lease. Calculate lease payments. Calculate loss on guarantee" resi"ual -alue lease. Calculate interest re-enue in sales-type lease. etermine gross profit an" interest re-enue. Calculate interest expense an" "epreciation expense for lessee. Calculate profit an" interest income for lessor0sales-type lease. Calculate profit on sales-type lease an" interest income.

Accounting for $eases c %). 7"entification of lease type for lessor.

21 - 0

$ULTIPLE CHOICECo(putat#onal -cont!.

Answe
' " " ' '

No!
&+. &1. &2. 9&3. 9&4.

"esc #pt#on
etermine "iscount rate implicit in lease payments. $ease-relate" expenses recogni!e" 'y lessee. etermine long-term lease o'ligation for lessee. ,ain recogni!e" 'y lessee in a sale-lease'ac:. 2ale-lease'ac:0operating lease.

$ULTIPLE CHOICECPA A)apte)

Answe
c a " a " " c a " "

No!
&5. &#. &%. &&. &). )+. )1. )2. 9)3. 9)4.

"esc #pt#on
7"entification of lease type for lessee. Calculate the lease lia'ility of a lessee. Calculate the lease lia'ility of a lessee. etermine re"uction of lease o'ligation for lessee. Calculate interest expense for lessee. Calculate "epreciation expense for lessee. 1ecognition of interest re-enue in a sales-type lease. Calculate income reali!e" 'y lessor0sales-type lease. 1eporting gain on a sale-lease'ac:. Accounting for the gain on a sale-lease'ac:.

E/ERCISES
Ite(
421-)5 421-)# 421-)% 421-)& 421-)) 421-1++ 9421-1+1 9421-1+2

"esc #pt#on
Capital lease <essay=. Capital lease amorti!ation an" >ournal entries. ;perating lease. $ease criteria for classification 'y lessor. irect-financing lease <essay=. $essor accounting?sales-type lease. $essee an" lessor accounting <sale-lease'ac:=. 2ale-lease'ac:.

PRO%LE$S
Ite(
521-1+3 521-1+4 521-1+5

"esc #pt#on
$essee accounting?capital lease. $essee accounting?capital lease. $essor accounting?"irect-financing lease.

21 - 3

Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

CHAPTER LEARNING O%1ECTI2ES

1. 2. 3. 4. 5. #. %. &. ). 91+ . 911. 4xplain the nature@ economic su'stance@ an" a"-antages of lease transactions. escri'e the accounting criteria an" proce"ures for capitali!ing leases 'y the lessee. Contrast the operating an" capitali!ation metho"s of recor"ing leases. 7"entify the classifications of leases for the lessor. escri'e the lessor8s accounting for "irect-financing leases. 7"entify special features of lease arrangements that cause uni3ue accounting pro'lems. escri'e the effect of resi"ual -alues@ guarantee" an" unguarantee"@ on lease accounting. escri'e the lessor8s accounting for sales-type leases. $ist the "isclosure re3uirements for leases. .n"erstan" an" apply lease accounting concepts to -arious lease arrangements. escri'e the lessee8s accounting for sale-lease'ac: transactions.

Accounting for $eases

21 - 9

SU$$AR4 OF LEARNING O%1ECTI2ES %4 5UESTIONS

Ite Ty Ite Ty Ite Ty Lea AC Lea AC AC AC AC AC AC Lea AC Lea AC AC Lea AC AC Lea AC Lea TF Lea AC AC AC Lea Ite Ty Ite Ty Ite Ty Ite Typ

1. 3. 4. 5. 2 2#. 5 2%. 2&. #. &. ). 1+. 11. 12. 14. 1%. 1&. 1). 2+. 4#. /oteB

TF TF TF TF AC AC AC TF TF TF TF TF TF TF TF TF TF TF AC

2. 2). 3+. 31. 32. 33. 4%. %. 3#. 3%. 3&. 3). 13. 15.
2 5

TF AC AC AC AC AC AC TF AC AC AC AC TF TF AC AC AC AC AC

21. 4&. 4). 5+. 52. 53. 54. 34. 51. ##. #%. #&. %2. 1#. 44. %4. %5.

41. 42. 43. 45. &3.

n#n* O67ect#8e 1 22. AC 23. n#n* O67ect#8e 2 55. AC #1. 5#. AC #2. 5%. AC #3. 5&. AC #4. 5). AC #5. #+. AC %#. n#n* O67ect#8e 0 5 35. AC #). n#n* O67ect#8e 3 %1. AC 1+1. %). AC n#n* O67ect#8e 9 &+. AC )). )&. 4 1+5. n#n* O67ect#8e : 1+4. 5 n#n* O67ect#8e ; 2 4+. AC %3. n#n* O67ect#8e < %%. AC )1. %&. AC )2. )+. AC )&. n#n* O67ect#8e =

AC AC AC AC AC AC AC AC 4

24. &1. &2. &5. &#. &%. &&. %+.

AC AC AC AC AC AC AC AC

25.

AC AC AC 4 4 5 5 4

&). )+. )5. )#. 1+3. 1+4. )%.

4 5

AC AC AC 4

1+5. 1++.

5 4

&4.

Lea n#n* O67ect#8e 11> AC )3. AC )4.

AC

1+1.

1+2.

TF C True-False AC C Aultiple Choice 4 C 4xercise 5 C 5ro'lem

21 - :

Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

TRUE-FALSEConceptual
1. 2. 3. 4. 5. #. %. &. ). 1+. 11. 12. 13. 14. 15. 1#. 1%. 1&. $easing e3uipment re"uces the ris: of o'solescence to the lessee@ an" passes the ris: of resi"ual -alue to the lessor. The FA2B agrees (ith the capitali!ation approach an" re3uires companies to capitali!e all long-term leases. A lease that contains a purchase option must 'e capitali!e" 'y the lessee. 4xecutory costs shoul" 'e exclu"e" 'y the lessee in computing the present -alue of the minimum lease payments. A capitali!e" lease" asset is al(ays "epreciate" o-er the term of the lease 'y the lessee. A lessee recor"s interest expense in 'oth a capital lease an" an operating lease. A 'enefit of leasing to the lessor is the return of the lease" property at the en" of the lease term. The "istinction 'et(een a "irect-financing lease an" a sales-type lease is the presence or a'sence of a transfer of title. $essors classify an" account for all leases that "on*t 3ualify as sales-type leases as operating leases. irect-financing leases are in su'stance the financing of an asset purchase 'y the lessee. .n"er the operating metho"@ the lessor recor"s each rental receipt as part interest re-enue an" part rental re-enue. 7n computing the annual lease payments@ the lessor "e"ucts only a guarantee" resi"ual -alue from the fair mar:et -alue of a lease" asset. Dhen the lessee agrees to ma:e up any "eficiency 'elo( a state" amount that the lessor reali!es in resi"ual -alue@ that state" amount is the guarantee" resi"ual -alue. Both a guarantee" an" an unguarantee" resi"ual -alue affect the lessee*s computation of amounts capitali!e" as a lease" asset. From the lessee*s -ie(point@ an unguarantee" resi"ual -alue is the same as no resi"ual -alue in terms of computing the minimum lease payments. The lessor (ill reco-er a greater net in-estment if the resi"ual -alue is guarantee" instea" of unguarantee". The primary "ifference 'et(een a "irect-financing lease an" a sales-type lease is the manufacturer*s or "ealer*s gross profit. The gross profit amount in a sales-type lease is greater (hen a guarantee" resi"ual -alue exists.

Accounting for $eases 1). 2+.

21 - ;

Companies must perio"ically re-ie( the estimate" unguarantee" resi"ual -alue in a sales-type lease. The FA2B re3uires lessees an" lessors to "isclose certain information a'out leases in their financial statements or in the notes.

T ue-False Answe sConceptual

Ite( 1. 2. 3. 4. 5. Ans! T F F T F Ite( #. %. &. ). 1+. Ans! F T F F T Ite( 11. 12. 13. 14. 15. Ans! F F T F T Ite( 1#. 1%. 1&. 1). 2+. Ans! F T F T T

$ULTIPLE CHOICEConceptual
21. Aa>or reasons (hy a company may 'ecome in-ol-e" in leasing to other companies is <are= a. interest re-enue. '. high resi"ual -alues. c. tax incenti-es. ". all of these. Dhich of the follo(ing is an a"-antage of leasingE a. ;ff-'alance-sheet financing '. $ess costly financing c. 1++F financing at fixe" rates ". All of these Dhich of the follo(ing 'est "escri'es current practice in accounting for leasesE a. $eases are not capitali!e". '. $eases similar to installment purchases are capitali!e". c. All long-term leases are capitali!e". ". All leases are capitali!e". Dhile only certain leases are currently accounte" for as a sale or purchase@ there is theoretic >ustification for consi"ering all leases to 'e sales or purchases. The principal reason that supports this i"ea is that a. all leases are generally for the economic life of the property an" the resi"ual -alue of the property at the en" of the lease is minimal. '. at the en" of the lease the property usually can 'e purchase" 'y the lessee. c. a lease reflects the purchase or sale of a 3uantifia'le right to the use of property. ". "uring the life of the lease the lessee can effecti-ely treat the property as if it (ere o(ne" 'y the lessee.

22.

23.

24.

21 - <
2

Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on An essential element of a lease con-eyance is that the a. lessor con-eys less than his or her total interest in the property. '. lessee pro-i"es a sin:ing fun" e3ual to one year8s lease payments. c. property that is the su'>ect of the lease agreement must 'e hel" for sale 'y the lessor prior to the "rafting of the lease agreement. ". term of the lease is su'stantially e3ual to the economic life of the lease" property. Dhat impact "oes a 'argain purchase option ha-e on the present -alue of the minimum lease payments compute" 'y the lesseeE a. /o impact as the option "oes not enter into the transaction until the en" of the lease term. '. The lessee must increase the present -alue of the minimum lease payments 'y the present -alue of the option price. c. The lessee must "ecrease the present -alue of the minimum lease payments 'y the present -alue of the option price. ". The minimum lease payments (oul" 'e increase" 'y the present -alue of the option price if@ at the time of the lease agreement@ it appeare" certain that the lessee (oul" exercise the option at the en" of the lease an" purchase the asset at the option price. The amount to 'e recor"e" as the cost of an asset un"er capital lease is e3ual to the a. present -alue of the minimum lease payments. '. present -alue of the minimum lease payments or the fair -alue of the asset@ (hiche-er is lo(er. c. present -alue of the minimum lease payments plus the present -alue of any unguarantee" resi"ual -alue. ". carrying -alue of the asset on the lessor8s 'oo:s. The metho"s of accounting for a lease 'y the lessee are a. operating an" capital lease metho"s. '. operating@ sales@ an" capital lease metho"s. c. operating an" le-erage" lease metho"s. ". none of these. Dhich of the follo(ing is a correct statement of one of the capitali!ation criteriaE a. The lease transfers o(nership of the property to the lessor. '. The lease contains a purchase option. c. The lease term is e3ual to or more than %5F of the estimate" economic life of the lease" property. ". The minimum lease payments <exclu"ing executory costs= e3ual or excee" )+F of the fair -alue of the lease" property. Ainimum lease payments may inclu"e a a. penalty for failure to rene(. '. 'argain purchase option. c. guarantee" resi"ual -alue. ". any of these. 4xecutory costs inclu"e a. maintenance. '. property taxes. c. insurance. ". all of these.

25.

2#.

2%.

2&.

2).

3+.

31.

Accounting for $eases 32.

21 - =

7n computing the present -alue of the minimum lease payments@ the lessee shoul" a. use its incremental 'orro(ing rate in all cases. '. use either its incremental 'orro(ing rate or the implicit rate of the lessor@ (hiche-er is higher@ assuming that the implicit rate is :no(n to the lessee. c. use either its incremental 'orro(ing rate or the implicit rate of the lessor@ (hiche-er is lo(er@ assuming that the implicit rate is :no(n to the lessee. ". none of these. 7n computing "epreciation of a lease" asset@ the lessee shoul" su'tract a. a guarantee" resi"ual -alue an" "epreciate o-er the term of the lease. '. an unguarantee" resi"ual -alue an" "epreciate o-er the term of the lease. c. a guarantee" resi"ual -alue an" "epreciate o-er the life of the asset. ". an unguarantee" resi"ual -alue an" "epreciate o-er the life of the asset. 7n the earlier years of a lease@ from the lessee8s perspecti-e@ the use of the a. capital metho" (ill ena'le the lessee to report higher income@ compare" to the operating metho". '. capital metho" (ill cause "e't to increase@ compare" to the operating metho". c. operating metho" (ill cause income to "ecrease@ compare" to the capital metho". ". operating metho" (ill cause "e't to increase@ compare" to the capital metho". A lessee (ith a capital lease containing a 'argain purchase option shoul" "epreciate the lease" asset o-er the a. asset8s remaining economic life. '. term of the lease. c. life of the asset or the term of the lease@ (hiche-er is shorter. ". life of the asset or the term of the lease@ (hiche-er is longer. Base" solely upon the follo(ing sets of circumstances in"icate" 'elo(@ (hich set gi-es rise to a sales-type or "irect-financing lease of a lessorE Transfers ;(nership Contains Bargain Collecti'ility of $ease Any 7mportant By 4n" ;f $easeE 5urchase ;ptionE 5ayments Assure"E .ncertaintiesE a. /o Ges Ges /o '. Ges /o /o /o c. Ges /o /o Ges ". /o Ges Ges Ges Dhich of the follo(ing (oul" not 'e inclu"e" in the $ease 1ecei-a'le accountE a. ,uarantee" resi"ual -alue '. .nguarantee" resi"ual -alue c. A 'argain purchase option ". All (oul" 'e inclu"e" 7n a lease that is appropriately recor"e" as a "irect-financing lease 'y the lessor@ unearne" income a. shoul" 'e amorti!e" o-er the perio" of the lease using the interest metho". '. shoul" 'e amorti!e" o-er the perio" of the lease using the straight-line metho". c. "oes not arise. ". shoul" 'e recogni!e" at the lease8s expiration.

33.

34.

35.

3#.

3%.

3&.

21 - 1? Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

2

3).

7n or"er to properly recor" a "irect-financing lease@ the lessor nee"s to :no( ho( to calculate the lease recei-a'le. The lease recei-a'le in a "irect-financing lease is 'est "efine" as a. the amount of fun"s the lessor has tie" up in the asset (hich is the su'>ect of the "irect-financing lease. '. the "ifference 'et(een the lease payments recei-a'le an" the fair mar:et -alue of the lease" property. c. the present -alue of minimum lease payments. ". the total 'oo: -alue of the asset less any accumulate" "epreciation recor"e" 'y the lessor prior to the lease agreement. 7f the resi"ual -alue of a lease" asset is guarantee" 'y a thir" party a. it is treate" 'y the lessee as no resi"ual -alue. '. the thir" party is also lia'le for any lease payments not pai" 'y the lessee. c. the net in-estment to 'e reco-ere" 'y the lessor is re"uce". ". it is treate" 'y the lessee as an a""itional payment an" 'y the lessor as reali!e" at the en" of the lease term. The primary "ifference 'et(een a "irect-financing lease an" a sales-type lease is the a. manner in (hich rental receipts are recor"e" as rental income. '. amount of the "epreciation recor"e" each year 'y the lessor. c. recognition of the manufacturer8s or "ealer8s profit at the inception of the lease. ". allocation of initial "irect costs 'y the lessor to perio"s 'enefite" 'y the lease arrangements. A lessor (ith a sales-type lease in-ol-ing an unguarantee" resi"ual -alue a-aila'le to the lessor at the en" of the lease term (ill report sales re-enue in the perio" of inception of the lease at (hich of the follo(ing amountsE a. The minimum lease payments plus the unguarantee" resi"ual -alue. '. The present -alue of the minimum lease payments. c. The cost of the asset to the lessor@ less the present -alue of any unguarantee" resi"ual -alue. ". The present -alue of the minimum lease payments plus the present -alue of the unguarantee" resi"ual -alue. For a sales-type lease@ a. the sales price inclu"es the present -alue of the unguarantee" resi"ual -alue. '. the present -alue of the guarantee" resi"ual -alue is "e"ucte" to "etermine the cost of goo"s sol". c. the gross profit (ill 'e the same (hether the resi"ual -alue is guarantee" or unguarantee". ". none of these. Dhich of the follo(ing statements is correctE a. 7n a "irect-financing lease@ initial "irect costs are a""e" to the net in-estment in the lease. '. 7n a sales-type lease@ initial "irect costs are expense" in the year of incurrence. c. For operating leases@ initial "irect costs are "eferre" an" allocate" o-er the lease term. ". All of these.

4+.

41.

42.

43.

44.

Accounting for $eases 45. The $ease $ia'ility account shoul" 'e "isclose" as a. all current lia'ilities. '. all noncurrent lia'ilities. c. current portions in current lia'ilities an" the remain"er in noncurrent lia'ilities. ". "eferre" cre"its.

21 - 11

94#.

Dhen a company sells property an" then leases it 'ac:@ any gain on the sale shoul" usually 'e a. recogni!e" in the current year. '. recogni!e" as a prior perio" a">ustment. c. recogni!e" at the en" of the lease. ". "eferre" an" recogni!e" as income o-er the term of the lease.

$ult#ple C,o#ce Answe sConceptual

Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans!

21. 22. 23. 24.

" " ' c

25. 2#. 2%. 2&.

a ' ' a

2). 3+. 31. 32.

c " " c

33. 34. 35. 3#.

a ' a a

3%. 3&. 3). 4+.

" a c "

41. 42. 43. 44.

c ' c "

45. 94#.

c "

$ULTIPLE CHOICECo(putat#onal
4%. ;n ecem'er 1@ 2++&@ 5ere! Corporation lease" office space for 1+ years at a monthly rental of H)+@+++. ;n that "ate 5ere! pai" the lan"lor" the follo(ing amountsB 1ent "eposit First month8s rent $ast month8s rent 7nstallation of ne( (alls an" offices H )+@+++ )+@+++ )+@+++ 4)5@+++ H%#5@+++

The entire amount of H%#5@+++ (as charge" to rent expense in 2++&. Dhat amount shoul" 5ere! ha-e charge" to expense for the year en"e" ecem'er 31@ 2++&E a. H)+@+++ '. H)4@125 c. H1&4@125 ". H4)5@+++ 4&. ;n Ianuary 1@ 2++&@ 5enn Corporation signe" a ten-year noncancela'le lease for certain machinery. The terms of the lease calle" for 5enn to ma:e annual payments of H1++@+++ at the en" of each year for ten years (ith title to pass to 5enn at the en" of this perio". The machinery has an estimate" useful life of 15 years an" no sal-age -alue. 5enn uses the straight-line metho" of "epreciation for all of its fixe" assets. 5enn accor"ingly accounte" for this lease transaction as a capital lease. The lease payments (ere "etermine" to ha-e a present -alue of H#%1@++& at an effecti-e interest rate of &F. Dith respect to this capitali!e" lease@ 5enn shoul" recor" for 2++& a. lease expense of H1++@+++. '. interest expense of H44@%34 an" "epreciation expense of H3&@+#&. c. interest expense of H53@#&1 an" "epreciation expense of H44@%34. ". interest expense of H45@#&1 an" "epreciation expense of H#%@1+1.

21 - 12 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on .se the follo(ing information for 3uestions 4) through 54. <Annuity ta'les on page 21-2+.= ;n Ianuary 1@ 2++&@ exter@ 7nc. signs a 1+-year noncancela'le lease agreement to lease a storage 'uil"ing from ,arr Darehouse Company. Collecti'ility of lease payments is reasona'ly pre"icta'le an" no important uncertainties surroun" the amount of costs yet to 'e incurre" 'y the lessor. The follo(ing information pertains to this lease agreement. <a= The agreement re3uires e3ual rental payments at the en" of each year. <'= The fair -alue of the 'uil"ing on Ianuary 1@ 2++& is H3@+++@+++J ho(e-er@ the 'oo: -alue to ,arr is H2@5++@+++. <c= The 'uil"ing has an estimate" economic life of 1+ years@ (ith no resi"ual -alue. "epreciates similar 'uil"ings on the straight-line metho". <e= exter

<"= At the termination of the lease@ the title to the 'uil"ing (ill 'e transferre" to the lessee. exter8s incremental 'orro(ing rate is 11F per year. ,arr Darehouse Co. set the annual rental to insure a 1+F rate of return. The implicit rate of the lessor is :no(n 'y exter@ 7nc.

<f= The yearly rental payment inclu"es H1+@+++ of executory costs relate" to taxes on the property. 4). Dhat is the amount of the minimum annual lease paymentE <1oun"e" to the nearest "ollar.= a. H1&&@23% '. H4%&@23# c. H4&&@23# ". H4)&@23# Dhat is the amount of the total annual lease paymentE a. H1&&@23% '. H4%&@23% c. H4&&@23% ". H4)&@23% From the lessor8s -ie(point@ (hat type of lease is in-ol-e"E a. 2ales-type lease '. 2ale-lease'ac: c. irect-financing lease ". ;perating lease From the lessee8s -ie(point@ (hat type of lease exists in this caseE a. 2ales-type lease '. 2ale-lease'ac: c. Capital lease ". ;perating lease exter@ 7nc. (oul" recor" "epreciation expense on this storage 'uil"ing in 2++& of <1oun"e" to the nearest "ollar.= a. H+. '. H25+@+++. c. H3++@+++. ". H4&&@23%.

5+.

51.

52.

53.

Accounting for $eases 54.

21 - 10

7f the lease (ere nonrene(a'le@ there (as no purchase option@ title to the 'uil"ing "oes not pass to the lessee at termination of the lease an" the lease (ere only for eight years@ (hat type of lease (oul" this 'e for the lesseeE a. 2ales-type lease '. irect-financing lease c. ;perating lease ". Capital lease Kuffman Company leases a machine from $incoln Corp. un"er an agreement (hich meets the criteria to 'e a capital lease for Kuffman. The six-year lease re3uires payment of H1+2@+++ at the 'eginning of each year@ inclu"ing H15@+++ per year for maintenance@ insurance@ an" taxes. The incremental 'orro(ing rate for the lessee is 1+FJ the lessor8s implicit rate is &F an" is :no(n 'y the lessee. The present -alue of an annuity "ue of 1 for six years at 1+F is 4.%)+%). The present -alue of an annuity "ue of 1 for six years at &F is 4.))2%1. Kuffman shoul" recor" the lease" asset at a. H5+)@25#. '. H4&&@##1. c. H434@3##. ". H41#@%)). ;n ecem'er 31@ 2++%@ 5ool Corporation lease" a ship from 1enn Company for an eightyear perio" expiring ecem'er 3+@ 2+15. 43ual annual payments of H2++@+++ are "ue on ecem'er 31 of each year@ 'eginning (ith ecem'er 31@ 2++%. The lease is properly classifie" as a capital lease on 5ool8s 'oo:s. The present -alue at ecem'er 31@ 2++% of the eight lease payments o-er the lease term "iscounte" at 1+F is H1@1%3@#&5. Assuming all payments are ma"e on time@ the amount that shoul" 'e reporte" 'y 5ool Corporation as the total o'ligation un"er capital leases on its ecem'er 31@ 2++& 'alance sheet is a. H1@+)1@+54. '. H1@+++@15). c. H&%1@+54. ". H1@2++@+++.

55.

5#.

.se the follo(ing information for 3uestions 5% an" 5&. ;n Ianuary 1@ 2++&@ alton Corporation signe" a fi-e-year noncancela'le lease for e3uipment. The terms of the lease calle" for alton to ma:e annual payments of H5+@+++ at the 'eginning of each year for fi-e years (ith title to pass to alton at the en" of this perio". The e3uipment has an estimate" useful life of % years an" no sal-age -alue. alton uses the straight-line metho" of "epreciation for all of its fixe" assets. alton accor"ingly accounts for this lease transaction as a capital lease. The minimum lease payments (ere "etermine" to ha-e a present -alue of H2+&@4)3 at an effecti-e interest rate of 1+F. 5%. 7n 2++&@ alton shoul" recor" interest expense of a. H15@&4). '. H2)@151. c. H2+@&4). ". H34@151. 7n 2++)@ alton shoul" recor" interest expense of a. H1+@&4). '. H12@434. c. H15@&4). ". H1%@434.

5&.

21 - 13 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on 5). ;n ecem'er 31@ 2++&@ o"" Corporation lease" a plane from Aero Company for an eight-year perio" expiring ecem'er 3+@ 2+1#. 43ual annual payments of H15+@+++ are "ue on ecem'er 31 of each year@ 'eginning (ith ecem'er 31@ 2++&. The lease is properly classifie" as a capital lease on o""*s 'oo:s. The present -alue at ecem'er 31@ 2++& of the eight lease payments o-er the lease term "iscounte" at 1+F is H&&+@2#4. Assuming the first payment is ma"e on time@ the amount that shoul" 'e reporte" 'y o"" Corporation as the lease lia'ility on its ecem'er 31@ 2++& 'alance sheet is a. H&&+@2#4. '. H&1&@2)+. c. H%)2@23&. ". H%3+@2#4.

.se the follo(ing information for 3uestions #+ an" #1. ;n Ianuary 1@ 2++&@ Carley Corporation signe" a fi-e-year noncancela'le lease for e3uipment. The terms of the lease calle" for Carley to ma:e annual payments of H#+@+++ at the en" of each year for fi-e years (ith title to pass to Carley at the en" of this perio". The e3uipment has an estimate" useful life of % years an" no sal-age -alue. Carley uses the straight-line metho" of "epreciation for all of its fixe" assets. Carley accor"ingly accounts for this lease transaction as a capital lease. The minimum lease payments (ere "etermine" to ha-e a present -alue of H22%@44& at an effecti-e interest rate of 1+F. #+. Dith respect to this capitali!e" lease@ for 2++& Carley shoul" recor" a. rent expense of H#+@+++. '. interest expense of H22@%45 an" "epreciation expense of H45@4&). c. interest expense of H22@%45 an" "epreciation expense of H32@4)3. ". interest expense of H3+@+++ an" "epreciation expense of H45@4&). Dith respect to this capitali!e" lease@ for 2++) Carley shoul" recor" a. interest expense of H22@%45 an" "epreciation expense of H32@4)3. '. interest expense of H2+@4#) an" "epreciation expense of H32@4)3. c. interest expense of H1)@+1) an" "epreciation expense of H32@4)3. ". interest expense of H14@4#) an" "epreciation expense of H32@4)3. Bar:ley Corporation is a lessee (ith a capital lease. The asset is recor"e" at H45+@+++ an" has an economic life of & years. The lease term is 5 years. The asset is expecte" to ha-e a mar:et -alue of H15+@+++ at the en" of 5 years@ an" a mar:et -alue of H5+@+++ at the en" of & years. The lease agreement pro-i"es for the transfer of title of the asset to the lessee at the en" of the lease term. Dhat amount of "epreciation expense (oul" the lessee recor" for the first year of the leaseE a. H)+@+++ '. H&+@+++ c. H#+@+++ ". H5+@+++

#1.

#2.

Accounting for $eases .se the follo(ing information for 3uestions #3 through #&. <Annuity ta'les on page 21-2+.=

21 - 19

Kay Corporation enters into an agreement (ith Aarly 1entals Co. on Ianuary 1@ 2++& for the purpose of leasing a machine to 'e use" in its manufacturing operations. The follo(ing "ata pertain to the agreementB <a= The term of the noncancela'le lease is 3 years (ith no rene(al option. 5ayments of H155@213 are "ue on ecem'er 31 of each year. <'= The fair -alue of the machine on Ianuary 1@ 2++&@ is H4++@+++. The machine has a remaining economic life of 1+ years@ (ith no sal-age -alue. The machine re-erts to the lessor upon the termination of the lease. <c= Kay "epreciates all machinery it o(ns on a straight-line 'asis. <"= Kay8s incremental 'orro(ing rate is 1+F per year. Kay "oes not ha-e :no(le"ge of the &F implicit rate use" 'y Aarly. <e= 7mme"iately after signing the lease@ Aarly fin"s out that Kay Corp. is the "efen"ant in a suit (hich is sufficiently material to ma:e collecti'ility of future lease payments "ou'tful. #3. Dhat type of lease is this from Kay Corporation8s -ie(pointE a. ;perating lease '. Capital lease c. 2ales-type lease ". irect-financing lease 7f Kay accounts for the lease as an operating lease@ (hat expenses (ill 'e recor"e" as a conse3uence of the lease "uring the fiscal year en"e" ecem'er 31@ 2++&E a. epreciation 4xpense '. 1ent 4xpense c. 7nterest 4xpense ". epreciation 4xpense an" 7nterest 4xpense 7f the present -alue of the future lease payments is H4++@+++ at Ianuary 1@ 2++&@ (hat is the amount of the re"uction in the lease lia'ility for Kay Corp. in the secon" full year of the lease if Kay Corp. accounts for the lease as a capital leaseE <1oun"e" to the nearest "ollar.= a. H115@213 '. H123@213 c. H12#@%34 ". H133@+%+ From the -ie(point of Aarly@ (hat type of lease agreement existsE a. ;perating lease '. Capital lease c. 2ales-type lease ". irect-financing lease 7f Aarly recor"s this lease as a "irect-financing lease@ (hat amount (oul" 'e recor"e" as $ease 1ecei-a'le at the inception of the leaseE a. H155@213 '. H3&5@))1 c. H4++@+++ ". H4#5@#3&

#4.

#5.

##.

#%.

21 - 1: Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on #&. Dhich of the follo(ing lease-relate" re-enue an" expense items (oul" 'e recor"e" 'y Aarly if the lease is accounte" for as an operating leaseE a. 1ental 1e-enue '. 7nterest 7ncome c. epreciation 4xpense ". 1ental 1e-enue an" epreciation 4xpense 2ele Company lease" e3uipment to 2nea" Company on Iuly 1@ 2++%@ for a one-year perio" expiring Iune 3+@ 2++&@ for H#+@+++ a month. ;n Iuly 1@ 2++&@ 2ele lease" this piece of e3uipment to Luir: Company for a three-year perio" expiring Iune 3+@ 2+11@ for H%5@+++ a month. The original cost of the e3uipment (as H4@&++@+++. The e3uipment@ (hich has 'een continually on lease since Iuly 1@ 2++3@ is 'eing "epreciate" on a straightline 'asis o-er an eight-year perio" (ith no sal-age -alue. Assuming that 'oth the lease to 2nea" an" the lease to Luir: are appropriately recor"e" as operating leases for accounting purposes@ (hat is the amount of income <expense= 'efore income taxes that each (oul" recor" as a result of the a'o-e facts for the year en"e" ecem'er 31@ 2++&E 2ele 2nea" Luir: a. H21+@+++ H<3#+@+++= H<45+@+++= '. H21+@+++ H<3#+@+++= H<%5+@+++= c. H&1+@+++ H<#+@+++= H<15+@+++= ". H&1+@+++ H<##+@+++= H<45+@+++=

#).

.se the follo(ing information for 3uestions %+ an" %1. 4""y lease" e3uipment to Koyle Company on Aay 1@ 2++&. At that time the collecti'ility of the minimum lease payments (as not reasona'ly pre"icta'le. The lease expires on Aay 1@ 2++). Koyle coul" ha-e 'ought the e3uipment from 4""y for H3@2++@+++ instea" of leasing it. 4""y8s accounting recor"s sho(e" a 'oo: -alue for the e3uipment on Aay 1@ 2++&@ of H2@&++@+++. 4""y8s "epreciation on the e3uipment in 2++& (as H3#+@+++. uring 2++&@ Koyle pai" H%2+@+++ in rentals to 4""y for the &-month perio". 4""y incurre" maintenance an" other relate" costs un"er the terms of the lease of H#4@+++ in 2++&. After the lease (ith Koyle expires@ 4""y (ill lease the e3uipment to another company for t(o years. %+. Ignoring income taxes@ the amount of expense incurre" 'y Koyle from this lease for the year en"e" ecem'er 31@ 2++&@ shoul" 'e a. H2)#@+++. '. H3#+@+++. c. H#5#@+++. ". H%2+@+++. The income 'efore income taxes "eri-e" 'y 4""y from this lease for the year en"e" ecem'er 31@ 2++&@ shoul" 'e a. H2)#@+++. '. H3#+@+++. c. H#5#@+++. ". H%2+@+++. Kite Company has a machine (ith a cost of H4++@+++ (hich also is its fair mar:et -alue on the "ate the machine is lease" to 1ich Company. The lease is for # years an" the machine is estimate" to ha-e an unguarantee" resi"ual -alue of H4+@+++. 7f the lessor8s interest rate implicit in the lease is 12F@ the six 'eginning-of-the-year lease payments (oul" 'e

%1.

%2.

Accounting for $eases a. '. c. ". %3. H)2@3#1. H&2@4#5. H%&@1&+. H##@##%.

21 - 1;

4stes Co. lease" a machine to ains Co. Assume the lease payments (ere ma"e on the 'asis that the resi"ual -alue (as guarantee" an" 4stes gets to recogni!e all the profits@ an" at the en" of the lease term@ 'efore the lessee transfers the asset to the lessor@ the lease" asset an" o'ligation accounts ha-e the follo(ing 'alancesB $ease" e3uipment un"er capital lease $ess accumulate" "epreciation--capital lease 7nterest paya'le ;'ligations un"er capital leases H4++@+++ 3&4@+++ H 1#@+++ H 1@52+ 14@4&+ H1#@+++

7f@ at the en" of the lease@ the fair mar:et -alue of the resi"ual -alue is H&@&++@ (hat gain or loss shoul" 4stes recor"E a. H#@4&+ gain '. H%@12+ loss c. H%@2++ loss ". H&@&++ gain %4. urham Company lease" machinery to 2anti Company on Iuly 1@ 2++&@ for a ten-year perio" expiring Iune 3+@ 2+1&. 43ual annual payments un"er the lease are H%5@+++ an" are "ue on Iuly 1 of each year. The first payment (as ma"e on Iuly 1@ 2++&. The rate of interest use" 'y urham an" 2anti is )F. The cash selling price of the machinery is H525@+++ an" the cost of the machinery on urham8s accounting recor"s (as H4#5@+++. Assuming that the lease is appropriately recor"e" as a sale for accounting purposes 'y urham@ (hat amount of interest re-enue (oul" urham recor" for the year en"e" ecem'er 31@ 2++&E a. H4%@25+ '. H4+@5++ c. H2+@25+ ". H+ 4'y Company lease" e3uipment to the Aills Company on Iuly 1@ 2++&@ for a ten-year perio" expiring Iune 3+@ 2+1&. 43ual annual payments un"er the lease are H&+@+++ an" are "ue on Iuly 1 of each year. The first payment (as ma"e on Iuly 1@ 2++&. The rate of interest contemplate" 'y 4'y an" Aills is )F. The cash selling price of the e3uipment is H5#+@+++ an" the cost of the e3uipment on 4'y8s accounting recor"s (as H4)#@+++. Assuming that the lease is appropriately recor"e" as a sale for accounting purposes 'y 4'y@ (hat is the amount of profit on the sale an" the interest re-enue that 4'y (oul" recor" for the year en"e" ecem'er 31@ 2++&E a. H#4@+++ an" H5+@4++ '. H#4@+++ an" H43@2++ c. H#4@+++ an" H21@#++ ". H+ an" H+

%5.

21 - 1< Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on .se the follo(ing information for 3uestions %# an" %%. 1isen Company@ a "ealer in machinery an" e3uipment@ lease" e3uipment to Foran@ 7nc.@ on Iuly 1@ 2++&. The lease is appropriately accounte" for as a sale 'y 1isen an" as a purchase 'y Foran. The lease is for a 1+-year perio" <the useful life of the asset= expiring Iune 3+@ 2+1&. The first of 1+ e3ual annual payments of H#21@+++ (as ma"e on Iuly 1@ 2++&. 1isen ha" purchase" the e3uipment for H3@)++@+++ on Ianuary 1@ 2++&@ an" esta'lishe" a list selling price of H5@4++@+++ on the e3uipment. Assume that the present -alue at Iuly 1@ 2++&@ of the rent payments o-er the lease term "iscounte" at &F <the appropriate interest rate= (as H4@5++@+++. %#. Assuming that Foran@ 7nc. uses straight-line "epreciation@ (hat is the amount of "epreciation an" interest expense that Foran shoul" recor" for the year en"e" ecem'er 31@ 2++&E a. H225@+++ an" H155@1#+ '. H225@+++ an" H1&+@+++ c. H2%+@+++ an" H155@1#+ ". H2%+@+++ an" H1&+@+++ Dhat is the amount of profit on the sale an" the amount of interest income that 1isen shoul" recor" for the year en"e" ecem'er 31@ 2++&E a. H+ an" H155@1#+ '. H#++@+++ an" H155@1#+ c. H#++@+++ an" H1&+@+++ ". H)++@+++ an" H3#+@+++ Aayer Company lease" e3uipment from $ennon Company on Iuly 1@ 2++&@ for an eightyear perio" expiring Iune 3+@ 2+1#. 43ual annual payments un"er the lease are H3++@+++ an" are "ue on Iuly 1 of each year. The first payment (as ma"e on Iuly 1@ 2++&. The rate of interest contemplate" 'y Aayer an" $ennon is &F. The cash selling price of the e3uipment is H1@&#1@&%5 an" the cost of the e3uipment on $ennon8s accounting recor"s (as H1@#5+@+++. Assuming that the lease is appropriately recor"e" as a sale for accounting purposes 'y $ennon@ (hat is the amount of profit on the sale an" the interest income that $ennon (oul" recor" for the year en"e" ecem'er 31@ 2++&E a. H+ an" H+ '. H+ an" H#2@4%5 c. H211@&%5 an" H#2@4%5 ". H211@&%5 an" H%4@4%5

%%.

%&.

.se the follo(ing information for 3uestions %) through &3. Bohl Co. purchases lan" an" constructs a ser-ice station an" car (ash for a total of H3#+@+++. At Ianuary 2@ 2++%@ (hen construction is complete"@ the facility an" lan" on (hich it (as constructe" are sol" to a ma>or oil company for H4++@+++ an" imme"iately lease" from the oil company 'y Bohl. Fair -alue of the lan" at time of the sale (as H4+@+++. The lease is a 1+-year@ noncancela'le lease. Bohl uses straight-line "epreciation for its other -arious 'usiness hol"ings. The economic life of the facility is 15 years (ith !ero sal-age -alue. Title to the facility an" lan" (ill pass to Bohl at termination of the lease. A partial amorti!ation sche"ule for this lease is as follo(sB 5ayments 7nterest Amorti!ation Balance Ian. 2@ 2++% H4++@+++.++ ec. 31@ 2++% H#5@+)&.13 H4+@+++.++ H25@+)&.13 3%4@)+1.&% ec. 31@ 2++& #5@+)&.13 3%@4)+.1) 2%@#+%.)4 34%@2)3.)3 ec. 31@ 2++) #5@+)&.13 34@%2).3) 3+@3#&.%4 31#@)25.1)

Accounting for $eases %). From the -ie(point of the lessor@ (hat type of lease is in-ol-e" a'o-eE a. 2ales-type lease '. 2ale-lease'ac: c. irect-financing lease ". ;perating lease Dhat is the "iscount rate implicit in the amorti!ation sche"ule presente" a'o-eE a. 12F '. 1+F c. &F ". #F

21 - 1=

&+.

&1.

The total lease-relate" expenses recogni!e" 'y the lessee "uring 2++& is (hich of the follo(ingE <1oun"e" to the nearest "ollar.= a. H#4@+++ '. H#5@+)& c. H%3@4)+ ". H#1@4)+ Dhat is the amount of the lessee8s lia'ility to the lessor after the paymentE <1oun"e" to the nearest "ollar.= a. H4++@+++ '. H3%4@)+2 c. H34%@2)4 ". H31#@)25 ecem'er 31@ 2++)

&2.

9&3.

The total lease-relate" income recogni!e" 'y the lessee "uring 2++& is (hich of the follo(ingE a. H -+'. H2@##% c. H4@+++ ". H4+@+++ ;n Iune 3+@ 2++&@ Colt sol" e3uipment to an unaffiliate" company for H%++@+++. The e3uipment ha" a 'oo: -alue of H#3+@+++ an" a remaining useful life of 1+ years. That same "ay@ Colt lease" 'ac: the e3uipment at H%@+++ per month for 5 years (ith no option to rene( the lease or repurchase the e3uipment. Colt8s rent expense for this e3uipment for the year en"e" ecem'er 31@ 2++&@ shoul" 'e a. H&4@+++. '. H42@+++. c. H35@+++. ". H2&@+++.

9&4.

$ult#ple C,o#ce Answe sCo(putat#onal

Ite(

4%. 4&. 4). 5+. 51. 52.

Ans ! '

Ite(

Ans!

Ite(

Ans!

Ite(

Ans!

Ite(

Ans!

Ite(

Ans!

Ite(

Ans!

c c " a c

53. 54. 55. 5#. 5%. 5&.

c " c c a '

5). #+. #1. #2. #3. #4.

" c c " ' '

#5. ##. #%. #&. #). %+.

c a c " a "

%1. %2. %3. %4. %5. %#.

a ' c c c a

%%. %&. %). &+. &1. &2.

' c c ' " "

9&3. 9&4.

' '

21 - 2? Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on Future Malue of ;r"inary Annuity of 1 5erio" 1 2 3 4 5 # % & ) 1+ 5F 1.+++++ 2.+5+++ 3.1525+ 4.31+13 5.525#3 #.&+1)1 &.142+1 ).54)11 11.+2#5# 12.5%%&) #F 1.+++++ 2.+#+++ 3.1&3#+ 4.3%4#2 5.#3%+) #.)%532 &.3)3&4 ).&)%4% 11.4)132 13.1&+%) &F 1.+++++ 2.+&+++ 3.24#4+ 4.5+#11 5.&###+ %.335)2 &.)22&+ 1+.#3##3 12.4&%5# 14.4&#5# 1+F 1.+++++ 2.1++++ 3.31+++ 4.#41++ #.1+51+ %.%15#1 ).4&%1% 11.435&) 13.5%)4& 15.)3%43 12F 1.+++++ 2.12+++ 3.3%44+ 4.%%)33 #.352&5 &.1151) 1+.+&)+1 12.2))#) 14.%%5## 1%.54&%4

5resent Malue of an ;r"inary Annuity of 1 5erio" 1 2 3 4 5 # % & ) 1+ 5F .)523& 1.&5)41 2.%2325 3.545)5 4.32)4& 5.+%5#) 5.%&#3% #.4#321 %.1+%&2 %.%21%3 #F .)434+ 1.&333) 2.#%3+1 3.4#511 4.2123# 4.)1%32 5.5&23& #.2+)%) #.&+1#) %.3#++) &F .)25)3 1.%&32# 2.5%%1+ 3.31213 3.))2%1 4.#22&& 5.2+#3% 5.%4##4 #.24#&) #.%1++& 1+F .)+)+) 1.%3554 2.4&#&5 3.1#)&# 3.%)+%) 4.3552# 4.&#&42 5.334)3 5.%5)+2 #.1445% 12F .&)2&# 1.#)++5 2.4+1&3 3.+3%35 3.#+4%& 4.11141 4.5#3%# 4.)#%#4 5.32&25 5.#5+22

$ULTIPLE CHOICECPA A)apte)

&5. $ease A "oes not contain a 'argain purchase option@ 'ut the lease term is e3ual to )+ percent of the estimate" economic life of the lease" property. $ease B "oes not transfer o(nership of the property to the lessee 'y the en" of the lease term@ 'ut the lease term is e3ual to %5 percent of the estimate" economic life of the lease" property. Ko( shoul" the lessee classify these leasesE $ease A $ease B a. ;perating lease Capital lease '. ;perating lease ;perating lease c. Capital lease Capital lease ". Capital lease ;perating lease ;n ecem'er 31@ 2++&@ Aen"e!@ 7nc. lease" machinery (ith a fair -alue of H&4+@+++ from Cey 1entals Co. The agreement is a six-year noncancela'le lease re3uiring annual payments of H1#+@+++ 'eginning ecem'er 31@ 2++&. The lease is appropriately accounte" for 'y Aen"e! as a capital lease. Aen"e!8s incremental 'orro(ing rate is 11F. Aen"e! :no(s the interest rate implicit in the lease payments is 1+F. The present -alue of an annuity "ue of 1 for # years at 1+F is 4.%)+&. The present -alue of an annuity "ue of 1 for # years at 11F is 4.#)5).

&#.

Accounting for $eases 7n its ecem'er 31@ 2++& 'alance sheet@ Aen"e! shoul" report a lease lia'ility of a. H#+#@52&. '. H#&+@+++. c. H%51@344. ". H%##@52&. &%.

21 - 21

;n ecem'er 31@ 2++%@ 5atten Co. lease" a machine from Bass@ 7nc. for a fi-e-year perio". 43ual annual payments un"er the lease are H#3+@+++ <inclu"ing H3+@+++ annual executory costs= an" are "ue on ecem'er 31 of each year. The first payment (as ma"e on ecem'er 31@ 2++%@ an" the secon" payment (as ma"e on ecem'er 31@ 2++&. The fi-e lease payments are "iscounte" at 1+F o-er the lease term. The present -alue of minimum lease payments at the inception of the lease an" 'efore the first annual payment (as H2@5+2@+++. The lease is appropriately accounte" for as a capital lease 'y 5atten. 7n its ecem'er 31@ 2++& 'alance sheet@ 5atten shoul" report a lease lia'ility of a. H1@)+2@+++. '. H1@&%2@+++. c. H1@%11@&++. ". H1@4)2@2++. A lessee ha" a ten-year capital lease re3uiring e3ual annual payments. The re"uction of the lease lia'ility in year 2 shoul" e3ual a. the current lia'ility sho(n for the lease at the en" of year 1. '. the current lia'ility sho(n for the lease at the en" of year 2. c. the re"uction of the lease lia'ility in year 1. ". one-tenth of the original lease lia'ility.

&&.

.se the follo(ing information for 3uestions &) an" )+. ;n Ianuary 2@ 2++&@ Aartine!@ 7nc. signe" a ten-year noncancela'le lease for a hea-y "uty "rill press. The lease stipulate" annual payments of H15+@+++ starting at the en" of the first year@ (ith title passing to Aartine! at the expiration of the lease. Aartine! treate" this transaction as a capital lease. The "rill press has an estimate" useful life of 15 years@ (ith no sal-age -alue. Aartine! uses straight-line "epreciation for all of its plant assets. Aggregate lease payments (ere "etermine" to ha-e a present -alue of H)++@+++@ 'ase" on implicit interest of 1+F. &). 7n its 2++& income statement@ (hat amount of interest expense shoul" Aartine! report from this lease transactionE a. H+ '. H5#@25+ c. H%5@+++ ". H)+@+++ 7n its 2++& income statement@ (hat amount of "epreciation expense shoul" Aartine! report from this lease transactionE a. H15+@+++ '. H1++@+++ c. H)+@+++ ". H#+@+++

)+.

21 - 22 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on )1. 7n a lease that is recor"e" as a sales-type lease 'y the lessor@ interest re-enue a. shoul" 'e recogni!e" in full as re-enue at the lease8s inception. '. shoul" 'e recogni!e" o-er the perio" of the lease using the straight-line metho". c. shoul" 'e recogni!e" o-er the perio" of the lease using the effecti-e interest metho". ". "oes not arise. Castro Co. manufactures e3uipment that is sol" or lease". ;n ecem'er 31@ 2++&@ Castro lease" e3uipment to 4rmler for a fi-e-year perio" en"ing ecem'er 31@ 2+13@ at (hich "ate o(nership of the lease" asset (ill 'e transferre" to 4rmler. 43ual payments un"er the lease are H22+@+++ <inclu"ing H2+@+++ executory costs= an" are "ue on ecem'er 31 of each year. The first payment (as ma"e on ecem'er 31@ 2++&. Collecti'ility of the remaining lease payments is reasona'ly assure"@ an" Castro has no material cost uncertainties. The normal sales price of the e3uipment is H%%+@+++@ an" cost is H#++@+++. For the year en"e" ecem'er 31@ 2++&@ (hat amount of income shoul" Castro reali!e from the lease transactionE a. H1%+@+++ '. H22+@+++ c. H23+@+++ ". H33+@+++ Carey sol" its hea"3uarters 'uil"ing at a gain@ an" simultaneously lease" 'ac: the 'uil"ing. The lease (as reporte" as a capital lease. At the time of the sale@ the gain shoul" 'e reporte" as a. operating income. '. an extraor"inary item@ net of income tax. c. a separate component of stoc:hol"ers8 e3uity. ". a "eferre" gain. ;n ecem'er 31@ 2++&@ e-in Corp. sol" a machine to 1yan an" simultaneously lease" it 'ac: for one year. 5ertinent information at this "ate follo(sB 2ales price Carrying amount 5resent -alue of reasona'le lease rentals <H%@5++ for 12 months N 12F= 4stimate" remaining useful life H)++@+++ &25@+++ &5@+++ 12 years

)2.

9)3.

9)4.

7n e-in*s ecem'er 31@ 2++& 'alance sheet@ the "eferre" profit from the sale of this machine shoul" 'e a. H&5@+++. '. H%5@+++. c. H1+@+++. ". H+.

$ult#ple C,o#ce Answe sCPA A)apte)

Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans! Ite( Ans!

&5. &#.

c a

&%. &&.

" a

&). )+.

" "

)1. )2.

c a

9)3. 9)4.

" "

Accounting for $eases

21 - 20

"ERI2ATIONS Co(putat#onal
No! Answe
4%. 4&. 4). 5+. 51. 52. 53. 54. 55. 5#. 5%. 5&. 5). #+. #1. #2. #3. ' c c " a c c " c c a ' " c c " '

"e #8at#on
H)+@+++ O H4)5@+++ 1 <???? P ?= C H)4@125. 1+ 12

H#%1@++& P .+& C H53@#&1@ H#%1@++& Q 15 C H44@%34. H3@+++@+++ Q #.1445% C H4&&@23# <5M of ;r"inary Annuity Ta'le=. H4&&@23# O H1+@+++ C H4)&@23%. Conceptual@ FM excee"s cost. Conceptual. H3@+++@+++ Q 1+ C H3++@+++. &01+ C .& R %5F of economic life. <H1+2@+++ - H15@+++= P 4.))2%1 C H434@3##. H1@1%3@#&5 S H2++@+++ C H)%3@#&5 P .1+ C H)%@3#) H)%3@#&5 S <H2++@+++ S H)%@3#)= C H&%1@+54. <H2+&@4)3 S H5+@+++= P .1+ C H15@&4). TH15&@4)3 S <H5+@+++ - H15@&4)=U P .1+ C H12@434. H&&+@2#4 S H15+@+++ C H%3+@2#4. H22%@44& P .1+ C H22@%45J <H22%@44& S += Q % C H32@4)3. TH22%@44& S <H#+@+++ S H22@%45=U P .1+ C H1)@+1). <H45+@+++ S H5+@+++= Q & C H5+@+++. H155@213 P 2.4&#&5 C H3&5@))1J H3&5@))1 ???? C )#F R )+F. H4++@+++

#4. #5. ##. #%.

' c a c

Conceptual. H4++@+++ S TH155@213 S <H4++@+++ P .1=U C H2&4@%&%. H155@213 S <H2&4@%&% P.1= C H12#@%34. Fails to meet ,roup 77 re3uirements. Fair -alue C H4++@+++.

21 - 23 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

"ERI2ATIONS Co(putat#onal -cont!.

No! Answe
#&. #). " a

"e #8at#on
Conceptual. 2eleB 2nea"B Luir:B H%2+@+++. H%2+@+++ S H#4@+++ S H3#+@+++ C H2)#@+++. TH4++@+++ S <H4+@+++ P .5+##3=U Q 4.#+4%& C H&2@4#5. H&@&++ S H1#@+++ C <H%@2++=. <H525@+++ S H%5@+++= P .+) P #012 C H2+@25+. H5#+@+++ S H4)#@+++ C H#4@+++J <H5#+@+++ S H&+@+++= P .+) P #012 C H21@#++. H4@5++@+++ 1 ????? P ? C H225@+++. 1+ 2 <H4@5++@+++ S H#21@+++= P .+4 C H155@1#+. <H#+@+++ P #= O <H%5@+++ #= S <4@&++@+++ Q &= C H21+@+++ <H#+@+++= P # C H<3#+@+++= <H%5@+++= P # C H<45+@+++=.

%+. %1. %2. %3. %4. %5. %#.

" a ' c c c a

%%. %&. %). &+.

' c c '

H4@5++@+++ S H3@)++@+++ C H#++@+++. <H4@5++@+++ S H#21@+++= P .+4 C H155@1#+. H1@&#1@&%5 S H1@#5+@+++ C H211@&%5. <H1@&#1@&%5 S H3++@+++= P .+4 C H#2@4%5. Conceptual. H4+@+++ H4++@+++ ???? C 1+F or ????? C #.144#9 H4++@+++ H#5@+)&.13 9#.144# C 5M factor of or"inary annuity of H1 for 1+ years at 1+F.

&1. &2. 9&3. 9&4.

" " ' '

T<H4++@+++ S H4+@+++= Q 15U O H3%@4)+ C H#1@4)+. H31#@)25 <2ee amorti!ation ta'le.= <H4++@+++ S H3#+@+++= Q 15 C H2@##%. H%@+++ P # C H42@+++.

Accounting for $eases

21 - 29

"ERI2ATIONS CPA A)apte)

No! Answe
&5. &#. &%. &&. &). )+. )1. )2. 9)3. 9)4. c a " a " " c a " "

"e #8at#on
Conceptual. <H1#+@+++ P 4.%)+&= S H1#+@+++ C H#+#@52&. H2@5+2@+++ S H#3+@+++ O H3+@+++ C H1@)+2@+++ <2++%=. H1@)+2@+++ S TH#++@+++ S <H1@)+2@+++ P .1+=U C H1@4)2@2++ <2++&=. Conceptual. H)++@+++ P .1+ C H)+@+++. H)++@+++ Q 15 C H#+@+++. Conceptual. H%%+@+++ S H#++@+++ C H1%+@+++. Conceptual. H&5@+++ ???? C ).44F@ V 1+F of FM of asset it is a minor lease'ac:. H)++@+++

E/ERCISES
E@! 21-=9?Capital lease <4ssay=. 4xplain the proce"ures use" 'y the lessee to account for a capital lease. Solut#on 21-=9 Dhen the capital lease metho" is use"@ the lessee treats the lease transactions as if the asset (ere 'eing purchase". The asset an" lia'ility are recor"e" at the lo(er of <1= the present -alue of the minimum lease payments <exclu"ing executory costs= or <2= the fair -alue of the asset at the inception of the lease. The present -alue of the lease payments is compute" using the lessee8s incremental 'orro(ing rate@ unless the implicit rate use" 'y the lessor is lo(er an" the lessee has :no(le"ge of it. The effecti-e-interest metho" is use" to allocate each lease payment 'et(een interest expense an" a re"uction of the lease lia'ility. 7f the lease transfers o(nership or contains a 'argain purchase option@ the asset is amorti!e" in a manner consistent (ith the lessee8s normal "epreciation policy on assets o(ne"@ o-er the economic life of the asset an" allo(ing for resi"ual -alue. 7f the lease "oes not transfer o(nership or contain a 'argain purchase option@ the lease" asset is amorti!e" o-er the lease term.

21 - 2: Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on E@! 21-=:?Capital lease amorti!ation an" >ournal entries. Din"om Co. as lessee recor"s a capital lease of machinery on Ianuary 1@ 2++&. The se-en annual lease payments of H35+@+++ are ma"e at the en" of each year. The present -alue of the lease payments at 1+F is H1@%+4@+++. Din"om uses the effecti-e-interest metho" of amorti!ation an" sum-of-the-years8-"igits "epreciation <no resi"ual -alue=. Inst uct#ons <1oun" to the nearest "ollar.= <a= 5repare an amorti!ation ta'le for 2++& an" 2++). <'= 5repare all of Din"om 8s >ournal entries for 2++&.

Solut#on 21-=: <a= ate 1010+& 120310+& 120310+) <'= Annual 5ayments H35+@+++ 35+@+++ 1+F 7nterest H1%+@4++ 152@44+ 1e"uction ;f $ia'ility H1%)@#++ 1)%@5#+ $ease $ia'ility H1@%+4@+++ 1@524@4++ 1@32#@&4+ 1@%+4@+++

$ease" Aachinery........................................................................ 1@%+4@+++ $ease $ia'ility................................................................... 7nterest 4xpense.......................................................................... $ease $ia'ility............................................................................... Cash................................................................................. epreciation 4xpense <%02& P H1@%+4@+++=.................................. Accumulate" epreciation ............................................... 1%+@4++ 1%)@#++

35+@+++ 42#@+++ 42#@+++

E@! 21-=;?;perating lease. 6ir'y Co. purchase" a machine on Ianuary 1@ 2++&@ for H1@+++@+++ for the express purpose of leasing it. The machine is expecte" to ha-e a fi-e-year life@ no sal-age -alue@ an" 'e "epreciate" on a straight-line monthly 'asis. ;n April 1@ 2++&@ un"er a cancela'le lease@ 6ir'y lease" the machine to Karley Company for H3++@+++ a year for a four-year perio" en"ing Aarch 31@ 2+12. 6ir'y incurre" total maintenance an" other relate" costs un"er the pro-isions of the lease of H15@+++ relating to the year en"e" ecem'er 31@ 2++&. Karley pai" H3++@+++ to 6ir'y on April 1@ 2++&. Inst uct#ons TAssume the operating metho" is appropriate for parts <a= an" <'=.U <a= .n"er the operating metho"@ (hat shoul" 'e the income 'efore income taxes "eri-e" 'y 6ir'y Co. from this lease for the year en"e" ecem'er 31@ 2++&E <'= Dhat shoul" 'e the amount of rent expense incurre" 'y Karley from this lease for the year en"e" ecem'er 31@ 2++&E

Accounting for $eases Solut#on 21-=; <a= 1e-enue 4010+&?120310+& <H3++@+++ P )012= 4xpensesB epreciation <H2++@+++ P )012= Aaintenance@ etc. 7ncome 'efore taxes

21 - 2;

H225@+++ H15+@+++ 15@+++ 1#5@+++ H #+@+++

<'=

1ent expense@ 4010+&?120310+& <H3++@+++ P )012= C H225@+++.

E@! 21-=<?$ease criteria for classification 'y lessor. Dhat are the criteria that must 'e satisfie" for a lessor to classify a lease as a "irect-financing or sales-type leaseE Solut#on 21-=< 7n or"er for a lessor to classify a lease as a "irect-financing or a sales-type lease@ the lease at the "ate of inception must satisfy one or more of the follo(ing ,roup 7 criteria <a@ '@ c@ an" "= an" 'oth of the follo(ing ,roup 77 criteria <a an" '=B ,roup 7 <a= The lease transfers o(nership of the property to the lessee. <'= The lease contains a 'argain purchase option. <c= The lease term is e3ual to %5F or more of the estimate" economic life of the lease" property. <"= The present -alue of the minimum lease payments <exclu"ing executory costs= e3uals or excee"s )+F of the fair -alue of the lease" property. ,roup 77 <a= Collecti'ility of the payments re3uire" from the lessee is reasona'ly pre"icta'le. <'= /o important uncertainties surroun" the amount of unreim'ursa'le costs yet to 'e incurre" 'y the lessor un"er the lease.

E@! 21-==? irect-financing lease <essay=. 4xplain the proce"ures use" to account for a "irect-financing lease. Solut#on 21-== The lessor recor"s the present -alue of the minimum lease payments <exclu"ing executory costs= plus the present -alue of the unguarantee" resi"ual -alue <a guarantee" resi"ual -alue is inclu"e" in the minimum lease payments= as $ease 1ecei-a'le an" remo-es the asset from the 'oo:s. The lessor recor"s payments recei-e" as a re"uction in $ease 1ecei-a'le an" 7nterest 1e-enue. 7nterest re-enue is recogni!e" 'y using the effecti-e-interest metho". The implicit interest rate is applie" to the "eclining 'alance of the $ease 1ecei-a'le 'alance. The implicit rate is the rate of interest that (ill "iscount the minimum lease payments <exclu"ing executory costs= an" the unguarantee" resi"ual -alue to the fair -alue of the asset at the inception of the lease.

21 - 2< Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on E@! 21-1???$essor accounting?sales-type lease. 5iper Corp. is a manufacturer of truc: trailers. ;n Ianuary 1@ 2++&@ 5iper Corp. leases ten trailers to 1unyan Company un"er a six-year noncancela'le lease agreement. The follo(ing information a'out the lease an" the trailers is pro-i"e"B 1. 2. 3. 4. Inst <a= <'= <c= <"= 43ual annual payments that are "ue on ecem'er 31 each year pro-i"e 5iper Corp. (ith an &F return on net in-estment <present -alue factor for # perio"s at &F is 4.#22&&=. Titles to the trailers pass to 1unyan at the en" of the lease. The fair -alue of each trailer is H5+@+++. The cost of each trailer to 5iper Corp. is H45@+++. 4ach trailer has an expecte" useful life of nine years. Collecti'ility of the lease payments is reasona'ly pre"icta'le an" there are no important uncertainties surroun"ing the amount of costs yet to 'e incurre" 'y 5iper Corp. uct#ons Dhat type of lease is this for the lessorE iscuss. Calculate the annual lease payment. <1oun" to nearest "ollar.= 5repare a lease amorti!ation sche"ule for 5iper Corp. for the first three years. 5repare the >ournal entries for the lessor for 2++& an" 2++) to recor" the lease agreement@ the receipt of the lease rentals@ an" the recognition of income <assume the use of a perpetual in-entory metho" an" roun" all amounts to the nearest "ollar=.

Solut#on 21-1?? <a= 7t is a sales-type lease to the lessor@ 5iper Corp. 5iper8s <the manufacturer= profit upon sale is H5+@+++@ (hich is recogni!e" in the year of sale <2++&=. 7t is not an operating lease 'ecause title to the assets passes to the lessee@ the present -alue <H5++@+++= of the minimum lease payments e3uals or excee"s )+F <H45+@+++= of the fair -alue of the lease" trailers@ collecti'ility is reasona'ly assure"@ an" no important uncertainties surroun" the amount of unreim'ursa'le costs yet to 'e incurre" 'y the lessor. The remaining accounting treatment is similar to that accor"e" a "irect-financing lease. <H5+@+++ P 1+= Q 4.#22&& C H1+&@15&. $ease Amorti!ation 2che"ule <$essor= Annual $ease 1ental H1+&@15& 1+&@15& 1+&@15& 7nterest on $ease 1ecei-a'le H4+@+++ 34@54% 2&@#5& $ease 1ecei-a'le 1eco-ery H#&@15& %3@#11 %)@5++ $ease 1ecei-a'le H5++@+++ 431@&42 35&@231 2%&@%31 5++@+++ 45+@+++ 5++@+++ 45+@+++

<'= <c=

ate 1010+& 120310+& 120310+) 1203101+ <"=

Ianuary 1@ 2++& $ease 1ecei-a'le......................................................................... Cost of ,oo"s 2ol"...................................................................... 2ales 1e-enue................................................................. 7n-entory...........................................................................

Accounting for $eases Solut#on 21-1?? <cont.= ecem'er 31@ 2++& Cash............................................................................................. $ease 1ecei-a'le............................................................. 7nterest 1e-enue.............................................................. ecem'er 31@ 2++) Cash............................................................................................. $ease 1ecei-a'le............................................................. 7nterest 1e-enue.............................................................. 1+&@15&

21 - 2=

#&@15& 4+@+++ 1+&@15& %3@#11 34@54%

>E@! 21-1?1?$essee an" lessor accounting <sale-lease'ac:=. ;n Ianuary 1@ 2++&@ Kartig Company sells lan" to ;rti! Corporation for H#@+++@+++@ an" imme"iately leases the lan" 'ac:. The follo(ing information relates to this transactionB 1. The term of the noncancela'le lease is 2+ years an" the title transfers to Kartig Company at the en" of the lease term. 2. The lan" has a cost 'asis of H5@+4+@+++ to Kartig. 3. The lease agreement calls for e3ual rental payments of H#11@112 at the en" of each year. 4. The lan" has a fair mar:et -alue of H#@+++@+++ on Ianuary 1@ 2++&. 5. The incremental 'orro(ing rate of Kartig Company is 1+F. Kartig is a(are that ;rti! Corporation set the annual rentals to ensure a rate of return of &F. #. Kartig Company pays all executory costs (hich total H255@+++ in 2++&. %. Collecti'ility of the rentals is reasona'ly pre"icta'le@ an" there are no important uncertainties surroun"ing the costs yet to 'e incurre" 'y the lessor. Inst uct#ons <a= 5repare the >ournal entries for the entire year 2++& on the 'oo:s of Kartig Company to reflect the a'o-e sale an" lease transactions <inclu"e a partial amorti!ation sche"ule an" roun" all amounts to the nearest "ollar.= <'= 5repare the >ournal entries for the entire year 2++& on the 'oo:s of ;rti! Corporation to reflect the a'o-e purchase an" lease transactions. >Solut#on 21-1?1 <a= Kartig Company <$essee= Ianuary 1@ 2++& Cash............................................................................................. #@+++@+++ $an".................................................................................. .nearne" 5rofit on 2ale-$ease'ac:................................. $ease" $an" .n"er Capital $eases............................................. #@+++@+++ $ease $ia'ility...................................................................

5@+4+@+++ )#+@+++ #@+++@+++

21 - 0? Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on >Solut#on 21-1?1 <cont.= Throughout 2++& 4xecutory Costs <7nsurance an" Taxes=....................................... Accounts 5aya'le an" Cash............................................. ecem'er 31@ 2++& .nearne" 5rofit on 2ale-$ease'ac:............................................. 1e-enue from 2ale-$ease'ac: <H)#+@+++ Q 2+=............... 7nterest 4xpense.......................................................................... $ease $ia'ility............................................................................... Cash................................................................................. 5artial $ease Amorti!ation 2che"ule ate 1010+& 120310+& <'= Annual $ease 5ayment H#11@112 7nterest &F H4&+@+++ 1e"uction of $ease ;'ligation H131@112 Balance H#@+++@+++ 5@&#&@&&& 255@+++ 255@+++

4&@+++ 4&@+++ 4&+@+++ 131@112 #11@112

;rti! Corporation <$essor= Ianuary 1@ 2++& $an"............................................................................................. #@+++@+++ Cash................................................................................. $ease 1ecei-a'le......................................................................... #@+++@+++ $an".................................................................................. ecem'er 31@ 2++& Cash............................................................................................. $ease 1ecei-a'le............................................................. 7nterest 1e-enue.............................................................. #11@112

#@+++@+++ #@+++@+++

131@112 4&+@+++

>E@! 21-1?2?2ale-lease'ac:. ;n Ianuary 1@ 2++&@ ;(ings Co. sells machinery to A'er Corp. at its fair -alue of H4&+@+++ an" leases it 'ac:. The machinery ha" a carrying -alue of H42+@+++@ the lease is for 1+ years an" the implicit rate is 1+F. The lease payments of H%1@+++ start on Ianuary 1@ 2++&. ;(ings uses straight-line "epreciation an" there is no resi"ual -alue. Inst uct#ons <a= 5repare all of ;(ings8s entries for 2++&. <'= 5repare all of A'er8s entries for 2++&.

Accounting for $eases >Solut#on 21-1?2 <a= ;(ings Co. <$essee= Ianuary 1@ 2++& Cash............................................................................................. Aachinery......................................................................... .nearne" 5rofit on 2ale-$ease'ac:................................. $ease" Aachinery........................................................................ $ease $ia'ility................................................................... $ease $ia'ility............................................................................... Cash................................................................................. ecem'er 31@ 2++& epreciation 4xpense.................................................................. Accumulate" epreciation?Capital $ease....................... .nearne" 5rofit on 2ale-$ease'ac:............................................. epreciation 4xpense....................................................... 7nterest 4xpense T1+F P <H4&+@+++ S H%1@+++=U.......................... 7nterest 5aya'le................................................................ <'= A'er Corp. <$essor= Ianuary 1@ 2++& Aachinery..................................................................................... Cash................................................................................. $ease 1ecei-a'le......................................................................... Aachinery......................................................................... Cash............................................................................................. $ease 1ecei-a'le............................................................. ecem'er 31@ 2++& 7nterest 1ecei-a'le....................................................................... 7nterest 1e-enue..............................................................

21 - 01

4&+@+++ 42+@+++ #+@+++ 4&+@+++ 4&+@+++ %1@+++ %1@+++ 4&@+++ 4&@+++ #@+++ #@+++ 4+@)++ 4+@)++

4&+@+++ 4&+@+++ 4&+@+++ 4&+@+++ %1@+++ %1@+++ 4+@)++ 4+@)++

21 - 02 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on

PRO%LE$S
P ! 21-1?0?$essee accounting?capital lease. Korton Company@ as lessee@ enters into a lease agreement on Iuly 1@ 2++&@ for e3uipment. The follo(ing "ata are rele-ant to the lease agreementB 1. The term of the noncancela'le lease is 4 years@ (ith no rene(al option. 5ayments of H422@#&) are "ue on Iune 3+ of each year. 2. The fair -alue of the e3uipment on Iuly 1@ 2++& is H1@4++@+++. The e3uipment has an economic life of # years (ith no sal-age -alue. 3. Korton "epreciates similar machinery it o(ns on the sum-of-the-years8-"igits 'asis. 4. The lessee pays all executory costs. 5. Korton8s incremental 'orro(ing rate is 1+F per year. The lessee is a(are that the lessor use" an implicit rate of &F in computing the lease payments <present -alue factor for 4 perio"s at &F@ 3.31213J at 1+F@ 3.1#)&#. Inst uct#ons <a= 7n"icate the type of lease Korton Company has entere" into an" (hat accounting treatment is applica'le. <'= 5repare the >ournal entries on Korton8s 'oo:s that relate to the lease agreement for the follo(ing "atesB <1oun" all amounts to the nearest "ollar. 7nclu"e a partial amorti!ation sche"ule.= 1. Iuly 1@ 2++&. 2. ecem'er 31@ 2++&. 3. Iune 3+@ 2++). 4. ecem'er 31@ 2++).

Solut#on 21-1?0 <a= Capitali!e" amountB H422@#&) P 5M of an or"inary annuity for 4 perio"s at &F H422@#&) P 3.31213 C H1@4++@+++ Because the present -alue of the lease payments <H1@4++@+++= e3uals the fair -alue@ H1@4++@+++@ of the lease" property@ it is a capital lease an" must 'e accounte" for un"er the capital lease metho". <'= 1. Iuly 1@ 2++& $ease" 43uipment .n"er Capital $eases............................... 1@4++@+++ $ease $ia'ility............................................................. ecem'er 31@ 2++& epreciation 4xpense............................................................. Accumulate" epreciation?Capital $eases T<H1@4++@+++ P 401+= P #012U................................... 7nterest 4xpense <H112@+++ P #012=........................................ 7nterest 5aya'le.......................................................... 2&+@+++ 2&+@+++ 5#@+++ 5#@+++

1@4++@+++

2.

Accounting for $eases Solut#on 21-1?0 <cont.= $ease Amorti!ation 2che"ule ate %010+& #03+0+) #03+01+ 3. Annual $ease 5ayment H422@#&) 422@#&) 7nterest on .npai" ;'ligation H112@+++ &%@145 1e"uction of $ease ;'ligation H31+@#&) 335@544

21 - 00

Balance of $ease ;'ligation H1@4++@+++ 1@+&)@311 %53@%#%

Iune 3+@ 2++) 7nterest 4xpense...................................................................... $ease $ia'ility.......................................................................... Cash.............................................................................. <7nterest paya'le entry assume" to ha-e 'een re-erse" 1010+)= ecem'er 31@ 2++) epreciation 4xpense.............................................................. Accumulate" epreciation?Capital $eases.................. T<H1@4++@+++ P 401+= P #012 plus <H1@4++@+++ P 301+= P #012U 7nterest 4xpense <H&%@145 P #012=........................................... 7nterest 5aya'le.............................................................

112@+++ 31+@#&) 422@#&)

4.

4)+@+++ 4)+@+++

43@5%3 43@5%3

P ! 21-1?3?$essee accounting?capital lease. For'es Company on Ianuary 1@ 2++&@ enters into a fi-e-year noncancela'le lease@ (ith four rene(al options of one year each@ for e3uipment ha-ing an estimate" useful life of 1+ years an" a fair -alue to the lessor@ Kolt Corp.@ at the inception of the lease of H3@+++@+++. For'es8s incremental 'orro(ing rate is &F. For'es uses the straight-line metho" to "epreciate its assets. The lease contains the follo(ing pro-isionsB 1. 1ental payments of H21)@+++ inclu"ing H1)@+++ for property taxes@ paya'le at the 'eginning of each six-month perio". 2. A termination penalty assuring rene(al of the lease for a perio" of four years after expiration of the initial lease term. 3. An option allo(ing the lessor to exten" the lease one year 'eyon" the last rene(al exercise" 'y the lessee. 4. A guarantee 'y For'es Company that Kolt Corp. (ill reali!e H1++@+++ from selling the asset at the expiration of the lease. Ko(e-er@ the actual resi"ual -alue is expecte" to 'e H#+@+++. Inst <a= <'= <c= <"= uct#ons Dhat :in" of lease is this to For'es CompanyE Dhat shoul" 'e consi"ere" the lease termE Dhat are the minimum lease paymentsE Dhat is the present -alue of the minimum lease paymentsE <5M factor for annuity "ue of 2+ semi-annual payments at &F annual rate@ 14.133)4J 5M factor for amount "ue in 2+ interest perio"s at &F annual rate@ .45#3).= <1oun" to nearest "ollar.= <e= Dhat >ournal entries (oul" For'es recor" "uring the first year of the leaseE <7nclu"e an amorti!ation sche"ule through 1010+) an" roun" to the nearest "ollar.=

21 - 03 Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on Solut#on 21-1?3 <a= This lease is a capital lease to For'es Company 'ecause its term <1+ years?see computation in ' 'elo(= excee"s %5F of the e3uipment8s estimate" useful life. 7n a""ition@ the present -alue <see computation in " 'elo(= of the minimum lease payments <see computation in c 'elo(= excee"s )+F of the fair -alue of the e3uipment <H3@+++@+++=. The lease term isB /oncancela'le perio" A""itional perio" for (hich termination penalty assures rene(al 5erio" co-ere" 'y lessor extension option The minimum lease payments areB 2emi-annual rental payments 4xecutory costs /um'er of payments o-er lease term 1esi"ual guarantee Ainimum lease payments <"= The present -alue of the minimum lease payments isB Factor for present -alue of an annuity "ue@ 2+ perio"s@ 4F 2emi-annual payments@ net of executory costs Factor for present -alue of H1 "ue in 2+ interest perio"s at 4F .45#3) 1esi"ual guarantee P 1++@+++ 5resent -alue of lease payments <e= Ianuary 1@ 2++& $ease" 43uipment .n"er Capital $eases.................................... 2@&%2@42% $ease $ia'ility................................................................... Ianuary 1@ 2++& $eases $ia'ility............................................................................. 5roperty Taxes............................................................................. Cash................................................................................. Iuly 1@ 2++& $ease $ia'ility............................................................................... 5roperty Taxes ............................................................................ 7nterest 4xpense .......................................................................... Cash................................................................................. 2++@+++ 1)@+++ 21)@+++ )3@1+3 1)@+++ 1+#@&)% 21)@+++ 5 4 1 1+ years years year years

<'=

<c=

H 21)@+++ <1)@+++= 2++@+++ P 2+ 4@+++@+++ 1++@+++ H4@1++@+++ 14.133)4 H 2++@+++ 2@&2#@%&& 45@#3) H2@&%2@42%

2@&%2@42%

ate 7nitial 5M 1010+& %010+& 1010+)

$ease Amorti!ation 2che"ule 2emi-Annual 7nterest 1e"uction of $ease 5ayment 4F $ease ;'ligation H2++@+++ 2++@+++ 2++@+++ ? 1+#@&)% 1+3@1%3 H2++@+++ )3@1+3 )#@&2%

Balance H2@&%2@42% 2@#%2@42% 2@5%)@324 2@4&2@4)%

Accounting for $eases Solut#on 21-1?3 <cont.= ecem'er 31@ 2++& epreciation 4xpense.................................................................. Accumulate" epreciation?Capital $eases..................... 7nterest 4xpense.......................................................................... 7nterest 5aya'le ............................................................... 9<H2@&%2@42% S H#+@+++= Q 1+ C H2&1@243. P ! 21-1?9?$essor accounting?"irect-financing lease. 2&1@2439

21 - 09

2&1@243 1+3@1%3 1+3@1%3

Ien:s@ 7nc. enters into a lease agreement as lessor on Ianuary 1@ 2++&@ to lease an airplane to /ational Airlines. The term of the noncancela'le lease is eight years an" payments are re3uire" at the en" of each year. The follo(ing information relates to this agreementB 1. /ational Airlines has the option to purchase the airplane for H)@+++@+++ (hen the lease expires at (hich time the fair -alue is expecte" to 'e H15@+++@+++. 2. The airplane has a cost of H3&@+++@+++ to Ien:s@ an estimate" useful life of fourteen years@ an" a sal-age -alue of !ero at the en" of that time <"ue to technological o'solescence=. 3. /ational Airlines (ill pay all executory costs relate" to the lease" airplane. 4. Annual year-en" lease payments of H5@%##@425 allo( Ien:s to earn an &F return on its in-estment. 5. Collecti'ility of the payments is reasona'ly pre"icta'le@ an" there are no important uncertainties surroun"ing the costs yet to 'e incurre" 'y Ien:s. Inst uct#ons <a= Dhat type of lease is thisE iscuss. <'= 5repare a lease amorti!ation sche"ule for the lessor for the first t(o years <2++&-2++)=. <1oun" all amounts to nearest "ollar.= <c= 5repare the >ournal entries on the 'oo:s of the lessor to recor" the lease agreement@ to reflect payments recei-e" un"er the lease@ an" to recogni!e income@ for the years 2++& an" 2++). Solut#on 21-1?9 <a= The lease is a "irect-financing type lease from the lessor8s point of -ie( or a capital lease from the lessee8s point of -ie(. The lease contains a 'argain purchase option (hich satisfies one of the criteria for classification as a "irect-financing lease. The option to 'uy for H)@+++@+++ at the termination of the lease (hen the asset is expecte" to ha-e a fair -alue of H15@+++@+++ constitutes a 'argain purchase option. A""itionally@ the payments are collecti'le@ an" there are no uncertainties as to future lessor costs. $essor8s $ease Amorti!ation 2che"ule Annual 7nterest on $ease 1ecei-a'le $ease 1ental $ease 1ecei-a'le 1eco-ery $ease 1ecei-a'le H3&@+++@+++ H5@%##@4259 H3@+4+@+++ H2@%2#@425 35@2%3@5%5 5@%##@425 2@&21@&&# 2@)44@53) 32@32)@+3#

<'= ate 1010+& 120310+& 120310+)

9TH3&@+++@+++ S <H)@+++@+++ P .54+2%=U Q 5.%4##4 C H5@%##@425.

21 - 0: Test %an& 'o Inte (e)#ate Account#n*+ Twel't, E)#t#on Solut#on 21-1?9 <cont.= <c= Ianuary 1@ 2++& $ease 1ecei-a'le....................................................................... 3&@+++@+++ Airplanes......................................................................... 3&@+++@+++ ecem'er 31@ 2++& Cash........................................................................................... 5@%##@425 $ease 1ecei-a'le............................................................ 7nterest 1e-enue............................................................. ecem'er 31@ 2++) Cash........................................................................................... 5@%##@425 $ease 1ecei-a'le............................................................ 7nterest 1e-enue.............................................................

2@%2#@425 3@+4+@+++

2@)44@53) 2@&21@&&#