Junior Philippine Institute of Accountants

University of Cebu – Banilad Chapter

LEASES TEST BANK

MUTLIPLE CHOICE—Conceptual
1. Major reasons why a company may become involved in leasing to other companies is
(are)

a. interest revenue.
b. high residual values.
c. tax incentives.
d. all of these.

2. Which of the following is an advantage of leasing?

a. Off-balance-sheet financing
b. Less costly financing
c. 100% financing at fixed rates
d. All of these

3. Which of the following best describes current practice in accounting for leases?

a. Leases are not capitalized.

b. Leases similar to installment purchases are capitalized.
c. All long-term leases are capitalized.
d. All leases are capitalized.

4. While only certain leases are currently accounted for as a sale or purchase, there is
theoretic justification for considering all leases to be sales or purchases. The principal
reason that supports this idea is that

a. all leases are generally for the economic life of the property and the residual value of
the property at the end of the lease is minimal.
b. at the end of the lease the property usually can be purchased by the lessee.
c. a lease reflects the purchase or sale of a quantifiable right to the use of property.
d. during the life of the lease the lessee can effectively treat the property as if it were
owned by the lessee.
5. An essential element of a lease conveyance is that the

a. lessor conveys less than his or her total interest in the property.
b. lessee provides a sinking fund equal to one year's lease payments.
c. property that is the subject of the lease agreement must be held for sale by the lessor
prior to the drafting of the lease agreement.
d. term of the lease is substantially equal to the economic life of the leased property.

6. What impact does a bargain purchase option have on the present value of the minimum
lease payments computed by the lessee?

a. No impact as the option does not enter into the transaction until the end of the lease
term.
b. The lessee must increase the present value of the minimum lease payments by the
present value of the option price.
c. The lessee must decrease the present value of the minimum lease payments by the
present value of the option price.
d. The minimum lease payments would be increased by the present value of the option
price if, at the time of the lease agreement, it appeared certain that the lessee would
exercise the option at the end of the lease and purchase the asset at the option price.

7. The amount to be recorded as the cost of an asset under capital lease is equal to the

a. present value of the minimum lease payments.

b. present value of the minimum lease payments or the fair value of the asset, whichever
is lower.
c. present value of the minimum lease payments plus the present value of any
unguaranteed residual value.
d. carrying value of the asset on the lessor's books.

8. The methods of accounting for a lease by the lessee are

a. operating and capital lease methods.

b. operating, sales, and capital lease methods.
c. operating and leveraged lease methods.
d. none of these.

9. Which of the following is a correct statement of one of the capitalization criteria?

a. The lease transfers ownership of the property to the lessor.

b. The lease contains a purchase option.
c. The lease term is equal to or more than 75% of the estimated economic life of the
leased property.
d. The minimum lease payments (excluding executory costs) equal or exceed 90% of the
fair value of the leased property.
10. Minimum lease payments may include a

a. penalty for failure to renew.

b. bargain purchase option.
c. guaranteed residual value.
d. any of these.

11. Executory costs include

a. maintenance.
b. property taxes.
c. insurance.
d. all of these.

12. In order to properly record a direct-financing lease, the lessor needs to know how to
calculate the lease receivable. The lease receivable in a direct-financing lease is best
defined as

a. the amount of funds the lessor has tied up in the asset which is the subject of the
direct-financing lease.
b. the difference between the lease payments receivable and the fair market value of the
leased property.
c. the present value of minimum lease payments.
d. the total book value of the asset less any accumulated depreciation recorded by the
lessor prior to the lease agreement.

13. The Lease Liability account should be disclosed as

a. all current liabilities.

b. all noncurrent liabilities.
c. current portions in current liabilities and the remainder in noncurrent liabilities.
d. deferred credits.

14. When a company sells property and then leases it back, any gain on the sale should
usually be

a. recognized in the current year.

b. recognized as a prior period adjustment.
c. recognized at the end of the lease.
d. deferred and recognized as income over the term of the lease.
15. If the residual value of a leased asset is guaranteed by a third party

a. it is treated by the lessee as no residual value.

b. the third party is also liable for any lease payments not paid by the lessee.
c. the net investment to be recovered by the lessor is reduced.
d. it is treated by the lessee as an additional payment and by the lessor as realized at the
end of the lease term.

MULTIPLE CHOICE-Computational
1. On December 1, 2008, Perez Corporation leased office space for 10 years at a monthly
rental of $90,000. On that date Perez paid the landlord the following amounts:

Rent deposit $90,000

First month's rent 90,000
Last month's rent 90,000
Installation of new walls and offices 495,000
$765,000

The entire amount of $765,000 was charged to rent expense in 2008. What amount
should Perez have charged to expense for the year ended December 31, 2008?

a. $90,000
b. $94,125
c. $184,125
d. $495,000

2. On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for

certain machinery. The terms of the lease called for Penn to make annual payments of
$100,000 at the end of each year for ten years with title to pass to Penn at the end of this
period. The machinery has an estimated useful life of 15 years and no salvage value. Penn
uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly
accounted for this lease transaction as a capital lease. The lease payments were
determined to have a present value of $671,008 at an effective interest rate of 8%. With
respect to this capitalized lease, Penn should record for 2008

a. lease expense of $100,000.

b. interest expense of $44,734 and depreciation expense of $38,068.
c. interest expense of $53,681 and depreciation expense of $44,734.
d. interest expense of $45,681 and depreciation expense of $67,101

3. Huffman Company leases a machine from Lincoln Corp. under an agreement which
meets the criteria to be a capital lease for Huffman. The six-year lease requires payment
of $102,000 at the beginning of each year, including $15,000 per year for maintenance,
insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's
implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for
six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is
4.99271. Huffman should record the leased asset at

a. $509,256.
b. $488,661.
c. $434,366.
d. $416,799.

4. On December 31, 2007, Pool Corporation leased a ship from Renn Company for an
eight-year period expiring December 30, 2015. Equal annual payments of $200,000 are
due on December 31 of each year, beginning with December 31, 2007. The lease is
properly classified as a capital lease on Pool's books. The present value at December 31,
2007 of the eight lease payments over the lease term discounted at 10% is $1,173,685.
Assuming all payments are made on time, the amount that should be reported by Pool
Corporation as the total obligation under capital leases on its December 31, 2008 balance
sheet is

a. $1,091,054.
b. $1,000,159.
c. $871,054.
d. $1,200,000.

5. On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an
eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are
due on December 31 of each year, beginning with December 31, 2008. The lease is
properly classified as a capital lease on Dodd’s books. The present value at December 31,
2008 of the eight lease payments over the lease term discounted at 10% is $880,264.
Assuming the first payment is made on time, the amount that should be reported by Dodd
Corporation as the lease liability on its December 31, 2008 balance sheet is

a. $880,264.
b. $818,290.
c. $792,238.
d. $730,264.

ANSWERS:
MULTIPLE CHOICE – MULTIPLE CHOICE –
Conceptual Computational
1. D 6. B 11. D 1. B
2. D 7. B 12. C 2. C
3. B 8. A 13. C 3. C
4. C 9. C 14. D 4. C
5. A 10. D 15. D 5. D