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Question CPA-00395
Douglas Co. leased machinery with an economic useful life of six years. For tax purposes, the depreciable life is seven years. The lease is for five years, and Douglas can purchase the machinery at fair value at the end of the lease. What is the depreciable life of the leased machinery for financial reporting?
a. Zero.
b. Five years.
c. Six years.
d. Seven years.

Choice "b' is correct. Assets acquired under capital (finance) leases are depreciated using the same theory as purchased assets. The purchase option is for" fair value." It is not a "bargain purchase option" therefore the assumption cannot be made that Douglas Co. will acquire the machine at the end of the lease period. As a result, the machinery should be depreciated over the five-year lease term under both IFRS & U.S. GAAP.
Choice "a" is incorrect. Assets acquired under capital lease must be depreciated.
Choice "c" is incorrect. Although the machine has an economic life of six years, Douglas should depreciate the machinery over the five-year lease term because Douglas will most likely not keep the machinery after the lease term (there is no indication that Douglas will exercise the fair value purchase option).
Choice "d" is incorrect. Tax life is not used for financial accounting purposes.

Question CPA-00396
Cott, Inc. prepared an interest amortization table for a five-year lease payable with a bargain purchase option of $2,000, exercisable at the end of the lease. At the end of the five years, the balance in the leases payable column of the spreadsheet was zero. Cott has asked Grant, CPA, to review the spreadsheet to determine the error. Only one error was made on the spreadsheet. Which of the following statements represents the best explanation for this error?
a. The beginning present value of the lease did not include the present value of the bargain purchase option.
b. Cott subtracted the annual interest amount from the lease payable balance instead of adding it.
c. The present value of the bargain purchase option was subtracted from the present value of the annual payments.
d. Cott discounted the annual payments as an ordinary annuity, when the payments actually occurred at the beginning of each period

Choice "a" is correct. Cott, Inc. made the error of not including the present value of the bargain purchase option in the beginning present value of the lease that it used on the schedule. A bargain purchase option payment is included as part of the minimum lease payments to be discounted to the date of inception of the lease because it is a future cash flow that is considered certain. When the spreadsheet showed zero at the bottom, Cott, Inc. still was required to make the bargain purchase option payment of $2,000, yet there was no liability left on the books to pay. The $2,000 should have been capitalized as part of the cost of the equipment (or whatever was purchased under the capital lease).
Choice "b' is incorrect, Interest is neither subtracted nor added to the lease payable balance, which is maintained at the present value (or carrying value) of the lease. Interest is in a separate column on the spreadsheet for the effective interest method calculation.
Choice "c" is incorrect, If the present value of the bargain purchase option were subtracted from the present value of the annual payments, the balance could not have been zero at the end of five years, it would have been a debit balance (i.e., negative).
Choice "d" is incorrect. This option would have caused the amount capitalized at the lease inception to be lower than it should have been (i.e., the present value of an ordinary annuity for the same interest rate and amount of payments is lower than the present value of an annuity due). However, the schedule would not have become zero at the end because the interest calculation would have been based on the date of payment, which was not consistent with the method of discounting used to produce the schedule.

Question CPA-00397
On January 2, Year 1, Marx Co. as lessee signed a five-year noncancelable equipment lease with annual payments of $200,000 beginning December 31, Year I Marx treated this transaction as a capital (finance) lease. The five lease payments have a present value of $758,000 at January 2, Year 1, based on interest of 10%. What amount should Marx report as interest expense for the year ended December 31, Year 1?
a. $0
b. $48,400
c. $55,800
d. $75,800

Choice "d" is correct. The lease term began January 2, Year 1 on a lease valued at $758,000. The first payment of $200,000 was made on December 31, Year 1. Since the interest rate is 10% and one year has expired, Marx Co.'s interest expense is computed as 10% of $758,000 or $75,800. The remainder of the $200,000 payment reduces the obligation under the lease.
Choice "a" is incorrect. If the first payment had been made on January 2, the amount of interest would have been
$0 because none of the lease term had elapsed. Interest accrued between January 2 and December 31, which
Marx must account for.
Choice "b" is incorrect. Marx will pay 5 x $200,000 or 1,000,000 over the life of the lease or $1,000,000 - $758,000 = $242,000 total interest over the lease term. Simple interest for each of the five years would be $242,000 I 5 or $48,400. However, lease interest expense is computed using the effective interest method.
Choice "c" is incorrect. If the first payment had been made on January 2, the amount of interest would have been
$0 because none of the lease term had elapsed, and the lease obligation would have been reduced by the
$200,000 of the payment leaving an obligation of $558,000. Under these circumstances the interest expense
accrued between January 2 and December 31, which Marx must account for would be 10% of the reduced
amount or $55,800.

Question CPA-00398
In a sale-leaseback transaction, a gain resulting from the sale should be deferred at the time of the sale-leaseback
and subsequently amortized under U.S. GAAP when:
I. The seller-lessee has transferred substantially all the risks of ownership.
II. The seller-lessee retains the right to substantially all of the remaining use of the property.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II.

Choice "b' is correct. Recognition of a gain resulting from the sale in a sale-leaseback should be deferred when the seller-lessee retains the right to substantially all of the remaining use of the property (as in a capital lease).
Choice "a" is incorrect. When the seller-lessee transfers substantially all the risks of ownership (as in a true sale), any gain resulting from the sale should be recognized immediately.
Choice "c" is incorrect. When the seller-lessee transfers substantially all the risks of ownership, any gain resulting from the sale should be recognized rather than being deferred.
Choice "d" is incorrect. Recognition of the gain should be deferred when the seller-lessee retains the right to substantially all of the remaining use of the property.

Question CPA-00399
A six-year capital lease entered into on December 31, Year 1, specified equal minimum annual lease payments due on December 31 of each year. The first minimum annual lease payment, paid on December 31, Year 1, consists of which of the following?
Interest expense Lease liability
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Choice "c" is correct. The debt was incurred on December 31, Year 1. The initial payment was made on December 31, Year 1. No interest expense is recognized since no time has passed between when the debt was incurred and the payment was made. Thus, the full amount of the payment reduces the lease liability.
Choice "a" is incorrect. When payment is made on the same day as a debt is incurred, no interest expense is recognized since no time has passed since the debt was incurred.
Choice "b" is incorrect. Since no interest has accrued and the full payment reduces the liability.
Choice "d" is incorrect. Since no interest has accrued and the full payment reduces the liability.

Question CPA-00400
Glade Co. leases computer equipment to customers under U.S. GAAP direct-financing leases. The equipment has no residual value at the end of the lease and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a five-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for five years is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease?
a. $51,600
b. $75,000
c. $129,360
d. $139,450

Choice "a" is correct. The fair value of the equipment is equal the present value of the future cash flows.
PV annual rents x annuity due PV factor [n = 5, i = 8%]
$323,400 = annual rents x 4.312
Thus, annual rents = $75,000
Total cash flows = 5 x $75,000 = $375,000 and total interest revenue equals $51,600 [$375,000 total cash flows less $323,400 present value of cash flows].

Question CPA-00401
When should a lessor recognize in income a nonrefundable lease bonus paid by a lessee on signing an operating
lease?
a. When received.
b. At the inception of the lease.
c. At the expiration of the lease.
d. Over the life of the lease

Choice "d" is correct. Since the lease bonus is nonrefundable, it represents income attributable to the lease term. Therefore, recognition is deferred and recognized equally over the life of the lease.
Choice "a" is incorrect. Recognition of revenue when cash is received violates normal accrual accounting procedures.
Choice "b' is incorrect. Recognition of revenue when cash is received (i.e., at the inception of the lease) violates normal accrual accounting procedures.
Choice "c' is incorrect. The bonus is an integral part of the lease agreement and must be allocated over the life of the lease. If the amount were a deposit that was not refunded, then recognition would be at the expiration of the lease.

Question CPA-00402
Farm Co. leased equipment to Union Co. on July 1, Year 1, and properly recorded the sales-type (finance) lease at $135,000, the present value of the lease payments discounted at 10%. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, Year 1. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its Year I income statement?
a. $0
b. $5,500
c. $5,750
d. $6,750

Choice 'c" is correct. The initial lease receivable equals $135,000. After the first lease payment is received two days later, the lease receivable equals $115,000 ($135,000 less $20,000). Year I interest revenue equals $5,750 ($115,000x 10%x6/12).
Choice "a" is incorrect, Interest revenue on the lease receivable should be accrued.
Choice "b" is incorrect. Interest is not calculated on the cost of the assets.
Choice "d" is incorrect. The $20,000 payment received July 3 should be deducted from the receivable balance
before calculating interest

Question CPA-00403
At the inception of a capital (finance) lease, the guaranteed residual value should be:
a. Included as part of minimum lease payments at present value.
b. Included as part of minimum lease payments at future value.
c. Included as part of minimum lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.
d. Excluded from minimum lease payments.

Choice a" is correct. Guaranteed residual value is, in effect, an additional lease payment and must be included in the calculation of the present value of the minimum lease payments.
Choice 'b' is incorrect. Capital leases are valued at present value rather than future value.
Choice "c' is incorrect. Since the guaranteed residual value is effectively an additional lease payment, its full value
must be included in the calculation of the present value of the minimum lease payments.
Choice "d" is incorrect. Guaranteed residual value is, in effect, an additional lease payment.

Question CPA-00404
As an inducement to enter a lease, Graf Co., a lessor, granted Zep, Inc., a lessee, twelve months of free rent under a five-year operating lease. The lease was effective on January 1, Year 1, and provides for monthly rental payments to begin January 1, Year 2. Zep made the first rental payment on December 30, Year 1. In its Year 1 income statement, Graf should report rental revenue in an amount equal to:
a. Zero.
b. Cash received during Year 1.
c. One-fourth of the total cash to be received over the life of the lease.
d. One-fifth of the total cash to be received over the life of the lease.

Choice "d" is correct. Annual rental revenue equals the total rental revenue from the lease allocated over the full life of the lease. In this case, revenue equals total cash divided by five years.
Choice "a" is incorrect. Since a service was provided and the revenue is realizable through future collections, revenue must be recognized in Year 1.
Choice "b" is incorrect. Revenue is recognized when earned (a service is provided) and realizable (collectible in the future). Cash basis accounting would recognize revenue when cash was collected.
Choice "c" is incorrect. Revenue is recognized over the full life of the lease (five years) rather being limited to the time frame during which cash is collected.

Question CPA-00405
In the long-term liabilities section of its balance sheet at December 31, Year 1, Mene Co. reported a capital lease obligation of $75,000, net of current portion of $1,364. Payments of $9,000 were made on both January 2, Year 2, and January 2, Year 3. Mene's incremental borrowing rate on the date of the lease was 11% and the lessor's implicit rate, which was known to Mene, was 10%. In its December 31, Year 2, balance sheet, what amount should Mene report as capital lease obligation, net of current portion?
a. $66,000
b. $73,500
c. $73,636
d. $74,250

Choice 'b" is correct. The lesser of the lessee's incremental borrowing rate or the lessor's implicit rate (if known) should be used. The amortization of the lease is:
Cash Interest Principal Lease
Date Payment Expense Reduction Obligation
12/31/Year 1 $76,364
1/2/Year 2 $9,000 $7,636 $1,364 $75,000
12/31/Year 2 $75,000
1/2/Year 3 $9,000 $7,500 $1,500 $73,500
Date Short-term Long-term
12/31/Year 1 $1,364 $75,000
1/2/Year 2
12/31/Year 2 $1,500 $73,500
1/2/Year 3

Question CPA-00406
Under U.S. GAAP, one criterion for a capital lease is that the term of the lease must equal a minimum percentage of the leased propertys estimated economic life at the inception of the lease. What is this minimum percentage?
a. 51%
b. 75%
c. 80%
d. 90%

Choice "b' is correct. The U.S. GAAP lease term criterion is that the lease term be greater than or equal to 75% of the economic life of the leased asset.
Choice "a" is incorrect. 51% is not related to any of the capital lease criteria.
Choice 'c' is incorrect. 80% is not related to any of the capital lease criteria.
Choice 'd" is incorrect. Under U.S. GAAP, if the present value of the minimum lease payments is greater than or
equal to 90% of the fair value of the leased asset, then the lease is considered to be a capital lease.

Question CPA-00407
Oak Co. leased equipment for its entire nine-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next eight years. The present value on December 31, Year 1, of the nine lease payments over the lease term, using the rate implicit in the lease which Oak knows to be 10%, was $316,500. The December 31, Year 1, present value of the lease payments using Oak's incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as capital (finance) lease liability in its December 31, Year 2, balance sheet?
a. $350,000
b. $243,150
c. $228,320
d. $0

Choice "b" is correct. The initial amount capitalized is the present value using the lessor's rate if known (10%). The following table shows the liability on 12-31-Year 2.
Decline in
Date Payment Interest Liability 4Jj2iIit
12131/Year 1 $316,500
12/31/Year 1 $50,000 - $50,000 266,500
12131/Year 2 $50,000 26,650 23,350 243,150
Choice "a" is incorrect. The present value of the lease is used as the liability.
Choice "c" is incorrect. The lessor's rate if known (10%) is used for capital leases.
Choice "d" is incorrect. The lease is a capital (finance) lease, which must be recorded as an asset and liability on
the balance sheet.

Question CPA-00408
Neal Corp. entered into a nine-year capital (finance) lease on a warehouse on December 31 Year 1. Lease
payments of $52,000, which includes real estate taxes of $2,000, are due annually, beginning on December 31,
Year 2, and every December 31 thereafter. Neal does not know the interest rate implicit in the lease; Neal's
incremental borrowing rate is 9%. The rounded present value of an ordinary annuity for nine years at 9% is 56.
What amount should Neal report as capitalized (finance) lease liability at December 31, Year 1?
a. $280,000
b. $291,200
c. $450,000
d. $468,000

Choice "a" is correct. Capital (finance) leases should be recorded at the present value of the minimum lease payment (fair market value of property is not stated). The lease payment is used. Taxes should be expensed when paid.
$50,000 x 5.6 = $280,000
Choice 'b" is incorrect. The lease payment is used to compute the present value of the liability, not including executory costs, such as taxes. Executory costs are expensed when paid.
Choice "c is incorrect. The present value of the minimum lease payment is used.
Choice "d' is incorrect. The present value of the minimum lease payments is used.

Question CPA-00409
Howe Co. leased equipment to Kew Corp. on January 2, Year 1, for an eight-year period expiring December 31, Year 8. Equal payments under the lease are $600,000 and are due on January 2 of each year. The first payment was made on January 2, Year 1. The list selling price of the equipment is $3,520,000 and its carrying cost on Howe's books is $2,800,000. The lease is appropriately accounted for as a sales-type (finance) lease. The present value of the lease payments at an imputed interest rate of 12% (Howe's incremental borrowing rate) is $3,300,000. What amount of profit on the sale should Howe report for the year ended December 31, Year 1?
a. $720,000
b. $500,000
c. $90,000
d. $0

Choice "b' is correct. The excess of the present value of the selling price over its cost is recorded as profit.
Present value of payments $3,300,000
Carrying cost (2.800,000)
Profit on sale $ 500,000
Choice "a" is incorrect. The excess of the selling price (present value) over its cost is recorded as profit. The list
price is a distractor.
Choice 'c" is incorrect. The excess of the selling price (present value) over its cost is recorded as profit.
Choice "d" is incorrect. The excess of the selling price (present value) over its cost is recorded as profit.

Question CPA-0041 0
Wall Co. leased office premises to Fox, Inc. for a five-year term beginning January 2, Year 1. Under the terms of
the operating lease, rent for the first year is $8,000 and rent for years 2 through 5 is $12,500 per annum.
However, as an inducement to enter the lease, Wall granted Fox the first six months of the lease rent-free. In its
December 31, Year I income statement, what amount should Wall report as rental income?
a. $12,000
b. $11,600
c. $10,800
d. $8,000

Choice "c' is correct. Rental income is recorded when it is earned (accrual basis), not when the cash is received. Therefore the total rental income should be recognized ratably over the 5 years.
Rent in Year 1 (1/2 of $8,000) $ 4,000
Rent in Years 2-5 ($12,500 x 4) 50,000
Total rent $ 54,000
Year 1 Rent (1/5 x $54,000) $ 10,800
Choice "a" is incorrect. Rental income is recorded when it is earned (accrual basis), not when the cash is received. Therefore the total rental income should be recognized ratably over the 5 years.
Choice 'b' is incorrect. Only 1/2 of $8,000 is received in Year 1.
Choice "d" is incorrect. Rental income is recorded when it is earned (accrual basis), not when the cash is received. Therefore the total rental income should be recognized ratably over the 5 years.

Question CPA-0041 I
On January 2, Year 1 Non Mining Co. (lessee) entered into a 5-year lease for drilling equipment. Non accounted for the acquisition as a capital (finance) lease for $240,000, which includes a $10,000 bargain purchase option. At the end of the lease, Non expects to exercise the bargain purchase option. Non estimates that the equipment's fair value will be $20,000 at the end of its 8-year life. Non regularly uses straight-line depreciation on similar equipment. For the year ended December 31, Year 1, what amount should Non recognize as depreciation expense on the leased asset?
a. $48,000
b. $46,000
c. $30,000
d. $27,500

Choice "d" is correct. When a lease is capitalized because of transfer of title or bargain purchase, depreciation is based on the life of the asset, not the lease. The cost includes the bargain purchase price. Depreciation cannot be taken below the salvage value. Depreciation is:
($240,000 - 20,000)/8 years =
Choice "a" is incorrect. The life of the asset is used when the asset is capitalized because of bargain purchase. Salvage value must also be considered.
Choice "b' is incorrect. The life of the asset is used when the asset is capitalized because of bargain purchase. Additionally, the salvage value and not the bargain purchase option is subtracted from the asset cost to determine the depreciable base.
Choice "c" is incorrect. Depreciation is computed on cost less salvage of $20,000.

Question CPA-0041 2
On June 1, of the current year, Oren Co. entered into a five-year nonrenewable lease, commencing on that date, for office space and made the following payments to Cant Properties:
Bonus to obtain lease $30,000
First month's rent 10,000
Last month's rent 10,000
In its income statement for the current year ended June 30, what amount should Oren report as rent expense?
a. $10,000
b. $10,500
c. $40,000
d. $50,000

Choice "b" is correct. Rent expense should include the first month's rent and an allocated portion of the bonus. The last month's rent should be shown as a prepaid expense.
First month's rent $10,000
Amortize bonus ($30,000 x 1/60) 500
Total $10,500
Choice "a" is incorrect. The bonus should be allocated to expense on a straight-line basis over 60 months.
Choice "c" is incorrect. The bonus should be allocated to expense on a straight-line basis over 60 months.
Choice "d" is incorrect. The bonus should be allocated to expense on a straight-line basis over 60 months. The
last month's rent is shown as prepaid rent, not an expense.

Question CPA.0041 3
Star Co. leases a building for its product showroom. The ten-year nonrenewable lease will expire on December
31, Year 10. In January Year 5, Star redecorated its showroom and made leasehold improvements of $48,000.
The estimated useful life of the improvements is 8 years. Star uses the straight-line method of amortization. What
amount of leasehold improvements, net of amortization, should Star report in its June 30, Year 5, balance sheet?
a. $45,600
b. $45,000
c. $44,000
d. $43,200

Choice c" is correct. Leasehold improvements should be amortized over the lesser of the remaining life of the lease (6 years), the life of the improvement (8 years). $48,000 6 = $8,000 amortization for a year or $4,000 for January Year 5 through June 30, Year 5. $48,000 - $4,000 = $44,000.

Question CPA-00414
On December 31, of the current year, Dirk Corp. sold Smith Co. two airplanes and simultaneously leased them back. Additional information pertaining to the sale-leasebacks follows:
Plane #1 Plane #2
Sales price $600,000 $1,000,000
Carrying amount, 12/31 $100,000 $550,000
Remaining useful life, 12/31 10 years 35 years
Lease term 8 years 3 years
Annual lease payments $100,000 $200,000
In its December 31 balance sheet, what amount should Dirk report as deferred gain on these transactions under
U.S. GAAP?
a. $950,000
b. $500,000
c. $450,000
d. $0

Choice 'b" is correct. Because no present value information is given, we must assume that the Plane 1 lease is "major." It qualifies as a capital lease because it meets the 75% test (8 year term out of 10 year life is 80%). In "major" sale-leasebacks, all gain is deferred. We must also assume that the Plane 2 lease is "minor" because it will be classified as an operating lease (it fails all "OWNS" tests we are able to perform based on the given information). In "minor" sale-leasebacks, there is no deferral.
Choice "a" is incorrect. The leaseback on Plane 2 is considered minor because the lease life is less than 10% of its useful life. Therefore all gain is recognized on Plane 2.
Choice "c" is incorrect. The leaseback on Plane 2 is considered minor because the lease life is less than 10% of useful life. Therefore all gain is recognized rather than deferred on Plane 2.
Choice "d" is incorrect. Plane 1 is a capital lease since the lease term is greater than 75% of its useful life. The gain must be deferred.

Question CPAOO415
On January 1 Year 1, JCK Co. signed a contract for an eight-year lease of its equipment with a 10-year life. The present value of the 16 equal semiannual payments in advance equaled 85% of the equipment's fair value. The contract had no provision for JCK, the lessor, to give up legal ownership of the equipment. Should JCK recognize rent or interest revenue in Year 3, and should the revenue recognized in Year 3 be the same or smaller than the revenue recognized in Year 2 under U.S. GAAP?
Year 3 revenues Year 3 amount recognized
recognized compared to Year 2
a. Rent The same
b. Rent Smaller
c. Interest The same
d. Interest Smaller

Choice "d" is correct. The lease is a capital lease (lease term is 80% of asset life). Interest revenue is recognized for a capital lease, based on the discount rate times the carrying value of the lease receivable. As time passes, the lease receivable decreases and interest revenue recognized also decreases.

Question CPA-0041 7
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31, Year 1:
Sales price $400,000
Carrying amount $300,000
Monthly lease payment $3,250
Present value of lease payments $36,900
Estimated remaining life 25 years
Lease term 1 year
Implicit rate 12%
What amount of deferred gain on the sale should Mega report at December 31, Year I under U.S. GAAP?
a. $0
b. $36,900
c. $63,100
d. $100,000

Choice "a" is correct. $0 deferred gain in the 12/31/Year 1 balance sheet.
Under U.S. GAAP, when the seller-lessee retains only a minor portion (PV of leaseback is 10% or less of FV of the asset sold), any gain should be recognized immediately and none deferred.

Queshon CPA-0041 9
Robbins, Inc. leased a machine from Ready Leasing Co. The lease qualifies as a capital (finance) lease and requires 10 annual payments of $10,000 beginning immediately. The lease specifies an interest rate of 12% and a purchase option of $10,000 at the end of the tenth year, even though the machine's estimated value on that date is $20,000. Robbins' incremental borrowing rate is 14%. The present value of an annuity due of 1 at: 12% for 10 years is 6.328 and 14% for 10 years is 5.946. The present value of I at: 12% for 10 years is .322 and 14% for 10 years is .270.
What amount should Robbins record as lease liability at the beginning of the lease term?
a. $62,160
b. $64,860
c. $66,500
d. $69,720

Choice "c' is correct. The lessee should record the capital (finance) lease at the lower of (1) present value of
minimum lease payments or (2) FV of asset at the inception of lease. The FV is not given. The interest rate is
12% (lessor's rate is used only if lower or the implicit rate is not known). The lease payments begin immediately
(annuity due basis). The bargain purchase option must also be capitalized. The amount capitalized is:
Annual payments, $10,000 x 6.328 $63,280
Bargain purchase option, $10,000 x .322 3,220
$66500
Choice "a" is incorrect. The interest rate should be 12% since it is lower. Only when lessor's rate is lower and known to the lessee is it used.
Choice "b' is incorrect. The interest rate should be 12% since it is lower. The bargain purchase option is $10,000, not the machine's estimated value.
Choice "d" is incorrect. The bargain purchase option is $10,000, not the machine's estimated value.

Question CPA-00424
On December 31, Year 1, Day Co. leased a new machine from Parr with the following pertinent information:
Lease term 6 years
Annual rental payable at beginning of each year $50,000
Useful life of machine 8 years
Day's incremental borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of an annuity of I in advance for 6 periods at 12% 4.61
Present value of an annuity of I in advance for 6 periods at 15% 4.35
The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $375,500. At the beginning of the lease term, Day should record a lease liability of:
a. $375,500
b. $230,500
c. $217,500
d. $0

Choice 'b" is correct. $230,500 lease liability at 12-31-Yl.
Rule: A lease is a capital (finance) lease if its term is 75% or more of the life of the leased property under U.S. GAAP or the lease term is for a major part of the economic life under IFRS. The rate to use to calculate present value is the lessor's "implicit rate" if known by the lessee and if it is lower than the lessee's incremental borrowing rate.
Lease term y= 75% and is a capital lease
Life of machine 8 yr
Lease payment x PV factor at 12% = PV of lease
$50,000 x 4.61 = $230,500

Question CPA-00434
Lease A does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases under U.S. GAAP?
Lease A Lease B
a. Operating lease Capital lease
b. Operating lease Operating lease
c. Capital lease Capital lease
d. Capital lease Operating lease

Choice 'c' is correct. Both leases have terms equal to or more than 75% of their estimated economic life; therefore, both are capital leases under U.S. GAAP.
Rule: if any one of the following conditions is met, a lease is considered a capital lease under U.S. GAAP and is treated as if owned by the lessee:
1. The lease transfers ownership to the lessee by the end of the lease term.
2. The lease contains a bargain purchase option.
3. The present value at the beginning of the lease term of the "minimum lease payments" equals or exceeds
90% of the fair value of the leased property.
4. The lease term is 75% or more of the estimated economic life of the leased property.
Choice "a" is incorrect. Lease A is a capital lease.
Choice 'b' is incorrect. Both leases A and B are capital leases.
Choice "d" is incorrect. Lease B is a capital lease.

Question CPA-00438
On January 1 Year 1, Park Co. signed a 10-year operating lease for office space at $96,000 per year. The lease included a provision for additional rent of 5% of annual company sales in excess of $500,000. Park's sales for the year ended December 31, Year 1 were $600,000. Upon execution of the lease, Park paid $24,000 as a bonus for the lease. Park's rent expense for the year ended December 31, Year us:
a. $98,400
b. $101,000
c. $103,400
d. $125,000

Choice "c" is correct. $103,400 rent expense for Year 1.
Base rent (operating lease) $ 96,000
Additional rent ($600,000 —$500,000 $100,000 x 5%) 5,000
Amortization of lease bonus ($24,000 ÷ 10 yrs.) 2,400
Rent expense, Year 1 $103,400

Peg Co. leased equipment from Howe Corp. on July 1, Year 1 for an eight-year period expiring June 30, Year 9. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, Year 1. The rate of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe's accounting records is $2,800,000. The lease is appropriately recorded as a sales-type (finance) lease. What is the amount of profit on the sale and interest revenue that Howe should record for the year ended December 31, Year 1?
Profit on Interest
Sale Revenue
a. $720,000 $176,000
b. $720,000 $146,000
c. $45,000 $176,000
d. $45,000 $146,000

Choice 'b' is correct. $720,000 profit on sale and $146,000 interest revenue.
Rule: In a sales-type (finance) lease, any difference between the fair value of the leased asset and its carrying value is recognized as manufacturer's or dealer's profit:
Cash selling price of equipment $3,520,000
Less cost of equipment (2,800,000)
Profit recognized on sale $ 720,000
Rule: Unearned interest revenue in a sales-type lease is amortized over the period of the lease using the interest method:
PV at inception of the lease at 7/1/Year 1 $ 3,520,000
Less initial payment 7/1/Year 1 JQQO)
Balance during first year $ 2,920,000
Interest rate x 10%
Interest revenue 7/1/Yl to 6/30/Year 2 (12 mos) $ 292,000
Adjust from full year to half year x % yr
Interest revenue for year end 12/31/Year 1 $ 146,000

Question CPA-04675
On January 1 of the current year, Tell Co. leased equipment from Swill Co. under a 9-year sales-type (finance) lease. The equipment had a cost of $400,000 and an estimated useful life of 15 years. Semiannual lease payments of $44,000 are due every January 1 and July 1. The present value of lease payments at 12% was $505,000, which equals the sales price of the equipment. Using the straight-line method, what amount should Tell recognize as depreciation expense on the equipment in the current year?
a. $26,667
b. $33,667
c. $44,444
d. $56,111

Choice "d" is correct. The lessee records the lease as an asset and a liability at the lower (lesser) of the fair market value of the asset at the inception of the lease, or cost (present value of the minimum lease payments).
Lease should be depreciated (amortized) over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option.
Present value of minimum lease payments $505,000
÷ Lease term ÷ 9
= Straight-line depreciation expense $ 56,111

Question CPA-05204
Koby Co. entered into a capital lease with a vendor for equipment on January 2 for seven years. The equipment has no guaranteed residual value. The lease required Koby to pay $500,000 annually on January 2, beginning with the current year. The present value of an annuity due for seven years was 5.35 at the inception of the lease. What amount should Koby capitalize as leased equipment?
a. $500,000
b. $825,000
c. $2,675,000
d. $3,500,000

Choice 'c" is correct. The amount to be capitalized for a capital lease is the present value of the minimum lease payments. In this question, the minimum lease payments are $500,000 and the present value factor is 5.35. The present value of the minimum lease payments is thus $500,000 x.5.35, or $2,675,000.
Choice "a" is incorrect. The amount to capitalize for a capital lease is certainly not the $500,000 amount of the payment.
Choice "b" is incorrect. This is the difference between the total payments of $3,500,000 and the present value of those payments of $2,675,000.
Choice "d" is incorrect. The amount to capitalize for a capital lease is not the total value of the minimum lease payments ($500,000 x 7 = $3,500,000). It is the present value of the minimum lease payments and must include the present value factor in the computation

Question CPAO5237
Which of the following is a criterion for a lease to be classified as a capital lease in the books of a lessee under
U.S. GAAP?
a. The lease contains a bargain purchase option.
b. The lease does not transfer ownership of the property to the lessee.
c. The lease term is equal to 65% or more of the estimated useful life of the leased property.
d. The present value of the minimum lease payments is 70% or more of the fair market value of the leased property.

Choice 'a" is correct. One of the four U.S. GAAP criteria (OWNS) for a lease to be classified as a capital lease on the books of a lessee is the existence of a bargain purchase option.
Choice "b' is incorrect. One of the four U.S. GAAP criteria (OWNS) for a lease to be classified as a capital lease on the books of a lessee is that the lease does transfer ownership of the leased property to the lessee at the end of the lease.
Choice 'c" is incorrect. One of the four U.S. GAAP criteria (OWNS) for a lease to be classified as a capital lease on the books of a lessee is that the lease term is equal to 75%, not 65%, or more of the estimated useful life of the leased property.
Choice "d" is incorrect. One of the four U.S. GAAP criteria (OWNS) for a lease to be classified as a capital lease on the books of a lessee is that the present value of the minimum lease payments is 90%, not 70%, or more of the fair value of the leased property.

Question CPAO5438
On January 1, Year 1, Frost Co. entered into a two-year lease agreement with Ananz Co. to lease 10 new computers. The lease term begins on January 1, Year 1 and ends on December 31, Year 2. The lease agreement requires Frost to pay Ananz two annual lease payments of $8,000. The present value of the minimum lease payments is $13,000. Which of the following circumstances would require Frost to classify and account for the arrangement as a capital lease under U.S. GAAP?
a. The economic life of the computers is three years.
b. The fair value of the computers on January 1, Year 1 is $14,000.
c. Frost does not have the option of purchasing the computers at the end of the lease term.
d. Ownership of the computers remains with Ananz throughout the lease term and after the lease ends.

Choice 'b" is correct. For a lessee to account for a lease as a capital lease under U.S. GAAP, the terms of the lease must meet at least one of the capital lease criteria:
Ownership transfers at the end of the lease
Written option for bargain purchase
PV of minimum lease payments 90% of FV of leased property
Lease term 75% of asset useful life
If the fair value of the computers at lease inception is $14,000 and the present value of the minimum lease payments is $13,000, then the lease will be accounted for as a capital lease:
13,000/1 4,000 = 93%
Choice "a" is incorrect. If the economic life of the computers is 3 years and the lease term is 2 years, the lease will not be accounted for as a capital lease because the lease term is only 67% of the life of the asset.
Choice "c' is incorrect. If Frost does not have the option to purchase the computers at a discount or bargain price at the end of the lease term, then the lease will not be accounted for as a capital lease.
Choice "d" is incorrect. If ownership does not transfer to Frost, then the lease will not be accounted for as a capital lease.

Question CPA-05440
8am Co. entered into a 10-year lease agreement for a new piece of equipment worth $500,000. At the end of the lease, 8am will have the option to purchase the equipment. Which of the following would require the lease to be accounted for as a capital lease under U.S. GAAP?
a. The lease includes an option to purchase stock in the company.
b. The estimated useful life of the leased asset is 12 years.
c. The present value of the minimum lease payments is $400,000.
d. The purchase option at the end of the lease is at fair market value.

Choice b" is correct. For a lessee to account for a lease as a capital lease under U.S. GAAP, the terms of the lease must meet at least one of the capital lease criteria:
Ownership transfers at the end of the lease
Written option for bargain purchase
PV of minimum lease payments 90% of FV of leased property
Lease term Z 75% of asset useful life
If the lease term is 10 years and the useful life of the asset is 12 years, then the "75%" criteria is met (10/12 = 83%) and the lease will be accounted for as a capital lease.
Choice "a" is incorrect. An option to purchase stock in the lessor does not qualify a lease for capital lease treatment. To be accounted for as a capital lease, the lease must meet at least one of the criteria described above.
Choice 'c" is incorrect. If the present value of the minimum lease payments is $400,000 and the fair value of the equipment is $500,000, then the lease does not meet the "90%" criteria ($400,000/$500,000 = 80%) and will not be accounted for as a capital lease.
Choice "d' is incorrect. A bargain purchase option, not a fair value purchase option, qualifies a lease for capital lease accounting.

Question CPA-05456
Main, a pharmaceutical company, leased office space from Ash. Main took possession and began to use the building on July 1, Year 1. Rent was due the first day of each month. Monthly lease payments escalated over the 5-year period of the lease as follows:
Period
July 1, Year 1 - September 30, Year 1
October 1 Year 1 - June 30, Year 2
July 1, Year 2- June 30, Year 3
July 1 Year 3 - June 30, Year 4
July 1, Year 4 - June 30, Year 5
July 1, Year 5 - June 30, Year 6
Lease payment
$0 - rent abatement during move-in, construction
17,500
19,000
20,500
23,000
24,500
What amount would Main show as deferred rent expense at December 31, Year 4?
a. $50,658
b. $52,580
c. $68,575
d. $71,550

Choice "d" is correct. Rent expense must be recognized on a straight-line basis over the life of the lease. In this lease, rent expense and the balance in the deferred rent expense account are recognized as follows:

Total Lease Lease Deferred
!.yjnnts Expense Lease Expense
July 1, Year 1 - June 31, Year 2 $ 157,500 240,300 = $82,800
July 1, Year 2 - June 30, Year 3 228,000 240,300 12,300
July 1, Year 3 - June 30, Year 4 246,000 240,300 = (5,700)
July 1, Year 4 - June 30, Year 5 276,000 240,300 (35,700)
July 1, Year 5 - June 30, Year 6 294,000 240,300 = (53,700)
$1,201,500 /60 months = $20,025/month x 12 = $240,300 Deferred lease expense at December 31, Year 4 is therefore:
$82,800 + 12,300 + (5.700) ÷ (35,700 x 6/12) = $71,550
Choices "a", "b", and "c' are incorrect, per the explanation above.

Question CPA-05699
Which of the following is a characteristic of a capital lease under U.S. GAAP?
a. The lease term is substantially less than the estimated economic life of the leased property.
b. The lease contains a bargain-purchase option.
c. The present value of the minimum lease payments at the beginning of the lease term is 75% or more of the fair value of the property at the inception of the lease.
d. The future obligation does not appear in the balance sheet of the lessee.

Choice 'b" is correct. A lease that contains a bargain-purchase option will be accounted for by the lessee as a capital lease. At least one of the following criteria must be met for a lease to be capitalized:
• Ownership transfer at the end of the lease
• Bargain purchase option
• Present value of lease payments is at least 90% of the fair value of the leased property
• Lease term is at least 75% of the asset's economic life
Choice "a" is incorrect. If the lease term is substantially less than the estimated economic life of the leased property, then the lease must be accounted for as an operating lease. A lease is accounted for as a capital lease when the lease term is at least 75% of the asset's economic life.
Choice 'c' is incorrect. The present value of the minimum lease payments at the beginning of the lease term must be at least 90% (not 75%) of the fair value of the property at the inception of the lease.
Choice "d' is incorrect. When a lease is capitalized, the lessee reports the leased asset as a asset and the lease obligation as a liability on the balance sheet.

Question CPA-00576
On January 1, Year 1, Hooks Oil Co. sold equipment wfth a carrying amount of $100,000, and a remaining useful life of 10 years, to Maco Drilling for $150,000. Hooks immediately leased the equipment back under a 10-year (finance) lease with a present value of $150,000 and will depreciate the equipment using the straight-line method. Hooks made the first annual lease payment of $24,412 in December Year 1. In Hooks' December 31, Year 1, balance sheet, the unearned gain on equipment sale under IFRS should be:
a. $50,000
b. $45,000
c. $25,588
d. $0

Choice "b' is correct. $45,000 unearned gain on equipment sale at 12/31/Year 1.
Rule: Any profit on a sale-leaseback which is classified as a capital (finance) lease should be deferred and amortized in proportion to depreciation taken on the leased-back asset.
Selling price $ 150,000
Carrying value (100,000)
Gain to be deferred as of January 1, Year 1 $ 50,000 ÷ 10 years
Less amortization of gain for Year 1 (5,000)
Deferred gain 12/3llYear 1 $ 45,000

Question CPA-05922
Steam Co. acquired equipment under a capital (finance) lease for six years. Minimum lease payments were
$60,000 payable annually at year-end. The interest rate was 5% with an annuity factor for six years of 5.0757.
The present value of the payments was equal to the fair market value of the equipment. What amount should
Steam report as interest expense at the end of the first year of the lease?
a. $0
b. $3,000
c. $15,227
d. $18,000

Choice "c' is correct. The capital (finance) lease will be recorded by debiting leased asset and crediting capital lease obligation for $304,542 ($60,000 minimum lease payment x 5.0757 annuity factor). The interest expense in the first year will be calculated by multiplying the 5% interest rate times the capital (finance) lease obligation:
$304,542 x 5% = $15,227.
Choice "a" is incorrect. Interest expense must be reported each period on the capital (finance) lease obligation.
Choice 'b" is incorrect. Interest expense is calculated as the capitalize (finance) lease obligation times the interest rate, not the annual payment times the interest rate.
Choice "d" is incorrect. The capital (finance) lease obligation is calculated as the minimum lease payment times the annuity factor, not the minimum lease payment times the number of years.

Question CPAO6498
Which of the following criteria could result in a lease being classified as an operating lease under U.S. GAAP and
a finance lease under IFRS?
a. The lease contains a written bargain purchase option.
b. The lease term is for 88% of the economic life of the asset.
c. The lease transfers ownership of the asset to the lessee at the end of the lease term.
d. The present value of the minimum lease payments amounts to 88% of the fair value of the asset

Choice "d" is correct. If the present value of the minimum lease payments amounts to 88% of the fair value of the asset, the lease would be classified as an operating lease under U.S. GAAP and would most likely be classified as a finance lease under IFRS. Under IFRS, a lease is classified as a finance lease if the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset. An argument could be made that 88% is 'at least substantially all of the fair value of the asset."
Choice "a" is incorrect. A lease would be classified as a capital lease under U.S. GAAP and a finance lease under IFRS if the lease contains a written bargain purchase option.
Choice 'b" is incorrect. A lease would be classified as a capital lease under U.S. GAAP and a finance lease under IFRS if the lease term is for 88% of the economic life of the asset.
Choice "c" is incorrect. A lease would be classified as a capital lease under U.S. GAAP and a finance lease under IFRS if the lease transfers ownership of the asset to the lessee at the end of the lease term.

Question CPA-06499
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31, Year 1:
Sales price $400,000
Carrying amount $300,000
Monthly lease payments $3,250
Present value of lease payments $36,900
The estimated remaining life of the asset is 25 years and the lease term is 1 year. Mega uses IFRS. The sales price is equal to the fair value of the leaseback asset. What amount of deferred gain on the sale should Mega report at December 31, Year 1?
a. $0
b. $36,900
c. $63,100
d. $100,000

Choice "a" is correct. No gain is deferred. The leaseback will be classified as an operating lease because the lease does not transfer substantially all the risks and rewards inherent in ownership to the lessee (the present value of the lease payments is not substantially all of the fair value of the leased asset and the lease term is not a major part of the economic life of the asset). When the lease in an IFRS sale-leaseback transaction is classified as an operating lease and the sales price is equal to the fair value of the leaseback asset, any profit or loss is recognized immediately:
Recognized gain $400,000 sales price - $300,000 carrying amount $100,000

Question CPA-06500
Oak Co. leased equipment for its entire nine-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next eight years. Oak paid $3,000 in initial direct costs at lease inception. The present value on December 31, Year 1, of the nine lease payments over the lease term, using the rate implicit in the lease which Oak knows to be 10% was $316,500. The December 31, Year 1, the present value of the lease payments using Oak's incremental borrowing rate of 12% was $298,500. Oak accounts for the finance lease under IFRS and uses straight-line depreciation. What amount should Oak report as finance lease asset on its December 31, Year 2 balance sheet?
a. $265,333
b. $281,333
c. $284,000
d. $319,500

Choice "c' is correct. On December 31, Year 1, this lease should be recorded at present value using the lower implicit rate of 10%. Under IFRS, initial direct costs must be added to the finance lease asset at lease inception. This lease would be recorded using the following JE:
Dr: Finance lease asset $319,500
Cr: Finance lease obligation $316,500
Cr: Cash 3,000
The finance lease asset is then amortized over the lease term/useful life of 9 years:
Annual depreciation = $31950019 = $35,500
On December 31, Year 2, after recording one year of depreciation, the finance lease asset will be reported as:
Finance lease asset, 12/311Y2 = Finance lease asset, 12/311Y1 - Year 2 depreciation
= $319,500 - $35,500
= $284,000

Question CPA-06501
The following information pertains to a sale and leaseback of equipment by Mega Co. on December 31, Year 1:
Sales price $400,000
Carrying amount $300,000
Present value of lease payments $373,620
The estimated remaining life of the asset is 25 years and the lease term is 25 years. Mega uses IFRS. The sales price is equal to the fair value of the leaseback asset.
What amount of deferred gain on the sale should Mega report at December 31, Year 1?
a. $0
b. $36,900
c. $63,100
d. $100,000

Choice "d" is correct. The entire gain is deferred. The leaseback will be classified as a finance lease because the lease transfers substantially all the risks and rewards inherent in ownership to the lessee (the present value of the lease payments is substantially all of the fair value of the leased asset and the lease term is the entire economic life of the asset). When the lease in an IFRS sale-leaseback transaction is classified as a finance lease, all profit is deferred and amortized over the lease term.
Deferred gain = $400,000 sales price - $300,000 carrying amount = $100,000

Question CPA-06502
In a sale-leaseback transaction, a gain resulting from the sale should be deferred at the time of the sale-leaseback and subsequently amortized when:
I. The seller-lessee accounts for the lease as a finance lease.
II. The seller-lessee accounts for the lease as an operating lease and the sales price equals fair value.
Ill. The seller-lessee accounts for the lease as an operating lease and the sales price is above fair value.
IV. The seller-lessee accounts for the lease as an operating lease and the sales price is below fair value.
a. I only.
b. I and III.
c. I, Ill, and IV.
d. II, Ill, and IV.

Choice 'b' is correct. Under IFRS, recognition of a gain resulting from a sale-leaseback transaction should be deferred and subsequently amortized if the lease is classified as a finance lease, or the lease is classified as an operating lease and the sales price is above fair value. If the lease is classified as an operating lease and the sales price is equal to fair value, the gain is recognized immediately. If the lease is classified as an operating lease and the sales price is below fair value, the gain is recognized immediately (although losses may be deferred in certain circumstances).

Question CPA-06610
Able Co. leased equipment to Baker under a noncancellable lease with a transfer of title. Will Able record depreciation expense on the leased asset and interest revenue related to the lease?
Depreciation Interest
revenue
a. Yes Yes
b. Yes No
c. No No
d. No Yes

Choice 'd is correct. Baker, the lessee, will capitalize the lease (due to the transfer of title) and will incur both depreciation and interest expense. Able will earn and book interest income when the payments from Baker are received. Able will remove the asset from its books at the inception of the lease and will not depreciate the asset.

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