ACCT 202 - PRE-QUIZ #2 (Chapter 15) PROFESSOR FARINA

Student: ___________________________________________________________________________ 1. Capital leases are agreements that are formulated outwardly as leases, but are installment purchases in substance. True False 2. The criterion of 75% of economic life for classifying a lease as a capital lease is consistent with the basic premise that most of the risks and rewards of ownership occur during the first 75% of an asset's life. True False 3. In accounting for operating leases, the lessor, rather than the lessee, will recognize depreciation on the leased asset. True False 4. In addition to the criteria that must be met by the lessee, the lessor must meet additional conditions for classification as a nonoperating lease to satisfy the realization principle. True False 5. When accounting for a nonoperating lease, the lessee records the leased asset at the present value of the minimum lease payments or the asset's fair value, whichever is lower. True False 6. If the lessee is expected to take ownership of a leased asset at the end of the lease term, the lessor must use an estimated residual value when calculating the lease payments necessary to achieve a desired rate of return. True False 7. A bargain purchase option is defined as the option of purchasing leased property at a price that is equal to the expected fair value of a leased asset. True False 8. On a sale-leaseback transaction, any gain on the "sale" portion of the transaction is recognized immediately. True False 9. From the perspective of the lessee, leases may be classified as either: A. Direct financing or sales-type. B. Capital or direct financing. C. Capital or operating. D. Direct financing or operating.
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10. The four criteria provided in FASB Statement No. 13 for distinguishing a capital lease from an operating lease do not include: A. The agreement specifies that ownership transfers at the end of the lease term. B. The collectability of the lease payments must be reasonably predictable. C. The agreement contains a bargain purchase option. D. The noncancelable lease term is 75% or more of the useful life of the leased asset. 11. One of the four criteria for a capital lease specifies that the lease term be equal to or greater than: A. 75% of the expected economic life of the leased property. B. 90% of the expected economic life of the leased property. C. 80% of the expected economic life of the leased property. D. 50% of the expected economic life of the leased property. 12. For the lessee to account for a lease as a capital lease, the lease must meet: A. All four of the criteria specified by SFAS No. 13. B. Any one of the six criteria specified by SFAS No. 13. C. Any two of the criteria specified by SFAS No. 13. D. Any one of the four criteria specified by SFAS No. 13. For #13 16: Technoid Inc. sells computer systems. Technoid leases computers to Lone Star Company on January 1, 2009. The manufacturing cost of the computers was $12 million. This non-cancelable lease had the following terms: Lease payments: $2,466,754 semiannually; first payment at January 1, 2009; remaining payments at June 30 and December 31 each year through June 30, 2013. Lease term: 5 years (10 semi-annual payments) No residual value; no bargain purchase option Economic life of equipment: 5 years Implicit interest rate and lessee's incremental borrowing rate: 5% semi-annually Fair value of the computers at January 1, 2009: $20 million Collectability of the rental payments is reasonably assured, and there are no lessor costs yet to be incurred. 13. Technoid would account for this as: A. A capital lease. B. A direct financing lease. C. A sales type lease. D. An operating lease.

14. Lone Star Company would account for this as: A. A capital lease. B. A direct financing lease. C. A sales type lease. D. An operating lease. 15. What is the net carrying value of the lease liability in Lone Star's June 30, 2009 balance sheet? Round your answer to the nearest dollar. A. $15,943,154 B. $17,533,246 C. $21,000,000 D. None of these is correct. 16. What is the interest revenue that Technoid would report on this lease in its 2009 income statement? A. $0 B. $1,673,820 C. $876,882 D. None of these is correct. For #17 21: On December 31, 2008, Reagan Inc. signed a lease for some equipment having a 9-year useful life with Silver Leasing Co. The lease payments are made by Reagan annually, beginning at signing date. Title does not transfer to the lessee, so the equipment will be returned to the lessor on December 31, 2014. There is no bargain purchase option, and Reagan guarantees a residual value to the lessor on termination of the lease. Reagan's lease amortization schedule appears below:

17. In this situation, Reagan: A. Is the lessee in a sales type lease. B. Is the lessee in a capital lease. C. Is the lessor in a capital lease. D. Is the lessor in a sales type lease. 18. At what amount would Reagan record the leased asset at inception of the agreement? A. $519,115 B. $429,115 C. $540,000 D. $576,000 19. What is the effective annual interest rate charged to Reagan on this lease? A. 4% B. 6% C. 8% D. 17%. 20. What is the carrying value of the lease liability on Reagan's December 31, 2010 balance sheet (after the third lease payment is made)? A. $280,531 B. $190,530 C. $266,280 D. $356,280 21. What is the amount of residual value guaranteed by Reagan to the lessor? A. $ 1,385 B. $34,615 C. $36,000 D. Cannot be determined from the given information 22. On September 1, 2009, Custom Shirts Inc. entered into a lease agreement appropriately classified as an operating lease. The lease term is 3 years. The annual payments are (a) $20,000 for year 1, (b) $24,000 for year 2, and (c) $28,000 for year 3. How much rent expense will Custom Shirts recognize for 2009? A. $ 6,667. B. $24,000. C. $20,000. D. $ 8,000. 23. A direct financing lease is classified in the lessor's balance sheet as: A. An asset. B. A liability. C. Interest revenue. D. A contra account to lease liability.

For #24 26: Refer to the following lease amortization schedule. The five payments are made annually starting with the inception of the lease. A $2,000 bargain purchase option is exercisable at the end of the five-year lease. The asset has an expected economic life of eight years.

24. What is the effective annual interest rate? A. 9%. B. 10%. C. 11%. D. 20%. 25. What is the total interest over the term of the lease? A. $42,000. B. $ 8,200. C. $ 7,400. D. $ 3,460. 26. What would the lessee record as annual depreciation on the asset using the straight-line method, assuming no residual value? A. $3,325. B. $6,920. C. $4,325. D. $5,320. 27. S Corp. has a rate of return on assets of 10% and a debt / equity ratio of 2 to 1. Not including any indirect effects on earnings, the immediate impact of recording a capital lease on these ratios is a(an)

A. B. C. D.

28. On January 1, 2009, Calloway Company leased a machine to Zone Corporation. The lease qualifies as a direct financing lease. Calloway paid $240,000 for the machine and is leasing it to Zone for $34,000 per year, an amount that will return 10% to Calloway. The present value of the minimum lease payments is $240,000. The lease payments are due each January 1. What is the appropriate interest entry on December 31, 2009? A.

B.

C. D. 29. Francisco leased equipment from Julio on December 31, 2009. The lease is a 10-year lease with annual payments of $150,000 due on December 31 of each year. The present value of the lease (at a 10% implicit interest rate) is $1,020,000. Francisco's incremental borrowing rate is 12% for this type of lease. The implicit rate of 10% is known by the lessee. What should be the balance in Francisco lease liability at December 31, 2010? A. $824,400. B. $807,000. C. $806,400. D. $792,000. 30. A sales-type lease differs from a direct financing lease in one respect: A. The lessor receives a manufacturer's or dealer's profit. B. The lessor receives more interest than on a direct financing lease. C. The lessor receives less interest than on a direct financing lease. D. The lessor uses a longer amortization period than on a direct financing lease. 31. On January 1, 2009, Packard Corporation leased equipment to Hewlitt Company. The lease term is 8 years. The first payment of $450,000 was made on January 1, 2009. Remaining payments are made on December 31 each year, beginning with December 31, 2009. The equipment cost Packard Corporation $2,400,000. The present value of the minimum lease payments is $2,640,000. The lease is appropriately classified as a sales-type lease. Assuming the interest rate for this lease is 10%, what will be the balance reported as a liability by Hewlitt in the December 31, 2010, balance sheet? A. $1,950,000. B. $1,509,000. C. $1,959,000. D. $1,704,900.

32. When the lessee guarantees an estimated residual value of $75,000, the amount the lessee records as a leased asset and lease liability is increased by $75,000. True False 33. ABC Company leased equipment to Best Corporation under a lease agreement that qualifies as a direct financing lease. The cost of the asset is $120,000. The lease contains a bargain purchase option that is effective at the end of the fifth year. The expected economic life of the asset is ten years. The lease term is 5 years. The asset is expected to have a residual value of $2,000 at the end of ten years. Using the straight-line method, what would Best record as annual depreciation? A. $23,600. B. $12,200. C. $12,000. D. $11,800. 34. Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire that lease are called initial direct costs. Initial direct costs are matched with the interest revenues they help generate in A. an operating lease. B. a capital lease. C. a direct financing lease. D. a sales-type lease. 35. On December 31, 2009, Perry Corporation leased equipment to Admiral Company for a 5-year period. The annual lease payment, excluding executory costs is $40,000. The interest rate for this lease is 10%. The payments are due on December 31 of each year. The first payment was made on December 31, 2009. The normal cash price for this type of equipment is $125,000 while the cost to Perry was $105,000. For the year ended December 31, 2009, by what amount will Perry's pretax earnings increase from this lease? A. $20,000. B. $24,000. C. $28,500. D. $40,000. PROBLEM: Write the solution to the problem below on a separate piece of paper and attach it to the back of this pre-quiz.
At the beginning of 2009, Napoli Inc. acquired a machine with a fair market value of $6,155,468 by signing a four-year lease. The lease is payable in four annual payments of $1,900,000 at the end of each year. Required: 1. What is the effective rate of interest implicit in the agreement? 2. Prepare the lessees journal entry at the inception of the lease. 3. Prepare the journal entry to record the first lease payment at December 31, 2009. 4. Prepare the journal entry to record the second lease payment at December 31, 2010. 5. Suppose the fair value of the machine and the lessors implicit rate were unknown at the time of the lease, but that the lessees incremental borrowing rate of interest for notes of similar risk was 8%. Prepare the lessees entry at the inception of the lease.