Ch.20 Leases Verified Test Bank 13th Canadian Edition

CHAPTER 20

LEASES

CHAPTER STUDY OBJECTIVES

1. Understand the importance of leases from a business perspective. Leases represent a significant source of financing for companies. One of the issues identified by the IASB, prior to the adoption of IFRS 16, was a lack of transparency in financial reporting of leases, leaving users like financial analysts having to guess the extent of debt and leverage of many companies. Accounting for leases is not just an accounting issue, but one of importance to users of financial statements, including financial institutions and leasing companies.

2. Explain the conceptual nature, economic substance, and advantages of lease transactions. A lease is a contract between two parties that gives the lessee the right to use property that is owned by the lessor. In situations where the lessee obtains the use of the majority of the economic benefits inherent in a leased asset, the transaction is similar in substance to acquiring an asset. Therefore, the lessee recognizes the asset and associated liability and the lessor transfers the asset under lease accounting. The major advantages of leasing for the lessee relate to the cost and flexibility of the financing, and protection against obsolescence. For the lessor, the finance income is attractive.

3. Calculate the lease payment that is required for a lessor to earn a specific return. The lessor determines the investment that it wants to recover from a leased asset. If the lessor has acquired an asset for the purpose of leasing it, the lessor usually wants to recover the asset’s cost. If the lessor participates in leases as a way of selling its product, it usually wants to recover the sales price. The lessor’s investment in the cost or selling price can be recovered in part through a residual value if the asset will be returned to the lessor, or through a bargain purchase price that it expects the lessee to pay, if a bargain purchase is part of the lease agreement. In addition to these sources, the lessor recovers its investment through the lease payments. The periodic lease payment, therefore, is the annuity amount whose present value exactly equals the amount to be recovered through lease payments.

4. Identify and apply the factors that are used to determine if a contract is or contains a lease under IFRS and whether leases are capital or operating leases under the ASPE classification approach. Under IFRS, from the lessee’s standpoint, all leases are capitalized and included on the SFP except where the lessee elects not to apply the requirements for short-term leases or for leases where the underlying asset is of low value. Under ASPE a lease is classified as a capital or finance lease where the risks and benefits of owning the leased asset are transferred to the lessee, which is evidenced by one or more of the following: (1) the transfer of title or bargain purchase option (BPO), (2) the use of the majority of the asset services inherent in the leased asset, or (3) the recovery by the lessor of substantially all of its investment in the leased asset plus a return on that investment. If none of these criteria is met, the lease is classified as an operating lease.

5. Account for right-of-use assets by lessees under IFRS and capital leases under ASPE. IFRS 16 typically results in a right-of-use asset being capitalized on the lessee’s SFP and a lease liability being recognized for the obligation owing to the lessor. The amount capitalized is (a) the PV of the lease payments included in the lease liability (b) lease payments at the commencement date (c) initial direct costs of the lessee and (d) the costs of dismantling/restoring the underlying asset. The right-of-use asset is then depreciated in the same way as other capital assets owned by the lessee. Payments to the lessor are divided into an interest portion and a principal payment, using the effective interest method.

6. Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE). When a lessee guarantees a residual value, it is obligated to return either the leased asset or cash, or a combination of both, in an amount that is equal to the guaranteed value. The lessee includes the guaranteed residual (or amounts expected to be payable by the lessee under a residual value guarantee for IFRS) in the lease obligation/lease liability and leased asset/right-of-use asset calculation. The asset is depreciated to the guaranteed residual (or purchase option) value by the end of the lease term. If the residual value is unguaranteed (no amount is expected to be payable), the lessee takes no responsibility for the residual and it is excluded from the lessee’s calculations.

7. Account for operating leases by lessees under ASPE (and short-term leases and low-value leases under IFRS 16) and compare the operating and capitalization methods of accounting by lessees. A lessee recognizes the lease payments that are made as rent expense in the period that is covered by the lease, usually based on the proportion of time. Over the term of a lease, the total amount that is charged to expense is the same whether the lease has been treated as a direct financing lease or as an operating lease under ASPE. Differences relates to (1) the timing of recognition for the expense (more is charged in the early years for a direct financing lease), (2) the type of expense that is charged (depreciation and interest expense for a financing lease versus rent expense for an operating lease), and (3) the recognition of an asset and liability on the SFP for a financing lease versus non-recognition for an operating lease. Aside from any income tax differences, the cash flows for a lease are the same whether it is classified as an operating or financing lease. Accounting for short-term leases and exempt leases for low-value assets under IFRS 16 is similar to accounting for operating leases under ASPE, except that rental expenses would be considered short-term lease expense or low-value lease expense, respectively

8. Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required. The current portion of the obligation is the principal that will be repaid within 12 months from the SFP date. The current portion also includes the amount of interest that has accrued up to the SFP date. The long-term portion of the obligation or net investment is the principal balance that will not be paid within 12 months of the SFP date. Lessees disclose the same information as is required for capital assets and long-term debt in general. In addition, details are required of the future minimum lease payments for each of the next five years, and under IFRS, information about leasing arrangements is required.

9. Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach. If a lease, in substance, transfers the risks and benefits of ownership of the leased asset to the lessee and revenue recognition criteria related to collectability and ability to estimate any remaining non-reimbursable costs are met, the lessor accounts for the lease as either a direct financing or a sales-type lease. Under IFRS, it is classified as either a financing or a manufacturer or dealer lease. The existence of a manufacturer’s or dealer’s profit on the amount to be recovered from the lessee is the difference between a manufacturer/dealer or sales-type lease and a direct financing lease, because the objective is only to generate finance income in the latter. If any one of the capitalization or revenue recognition criteria is not met, the lessor accounts for the lease as an operating lease

10. Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor. In a finance lease, the lessor removes the cost of the leased asset from its books and replaces it with its net investment in the lease. This is made up of two accounts: (1) the gross investment or lease receivable, offset by (2) the portion of these amounts that represents unearned interest. The net investment represents the PV of the lease payments and the residual value or BPO amounts. As the lease payments are received, the receivable is reduced. As time passes, the unearned interest is taken into income based on the implicit rate of return that applies to the net investment. Under a manufacturer/dealer or sales-type lease, the accounting is similar except that the net investment represents the sales amount being recovered by the lessor. The lessor also transfers the inventory “sold” to cost of goods sold

11. Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor. For each type of finance or capital lease accounted for by lessors, the net investment in the lease includes the estimated residual value whether it is guaranteed or not, or the BPO amount. Under a manufacturer/dealer or sales-type lease, both the sale and cost of goods sold amounts are reduced by any unguaranteed residual values

12. Account for and report operating leases by a lessor. The lessor records the lease payments received from the lessee as rental income in the period covered by the lease payment. Because the leased asset remains on the lessor’s books, the lessor records depreciation expense. Separate disclosure is required of the cost and accumulated amortization of property held for leasing purposes, and the amount of rental income earned.

13. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. Under the classification approach, ASPE and IFRS 16 have substantially the same requirements for lessors. Different terminology is used and the classification requirements that differentiate between a capital/finance lease and an operating lease under IFRS are based more on principles and judgement than ASPE. Under IFRS 16 a contract-based or right-of-use approach is used by the lessee

14. Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate. A sale and leaseback is accounted for by the lessee as if the two transactions were related. If the transfer of the asset does not meet the criteria to be classified as a sale under IFRS 15, then no sale is recognized by the seller-lessee and no purchase is recognized by the buyer-lessor. On the other hand, when a seller-lessee leases back only a portion of the asset sold, then the right-of-use asset arising from the leaseback transaction would be measured at the proportion of the previous carrying amount of asset retained by the seller-lessee. For an operating lease under ASPE, the seller-lessee takes the deferred gain or loss into income in proportion to the rental payments made. For a lease meeting the capital lease criteria under ASPE, any profit or loss is deferred and amortized on the same basis as the depreciation of the leased asset.

Because the capitalization of land by the lessee in a capital or finance lease that does not transfer title results in an unwanted and unintended effect on the lessee’s financial statements, the portion of such leases that relates to land is accounted for as an operating lease. If the relative value of the land is minor, however, the minimum lease payments are fully capitalized as a building.

MULTIPLE CHOICE

Answer No. Description

b 1. Why accounting for leases is controversial

d 2. Who is accounting for leases important to?

b 3. Essential element of a lease agreement

c 4. Identification of executory costs

c 5. Calculating executory costs

a 6. Advantages of leasing

d 7. Current standards in lease accounting

c 8. Types of lessor companies

a 9. Journal entries for Capital/Finance leases by the lessor

d 10. Variables in deciding rate of return

c 11. Calculate minimum annual lease payment

d 12. Calculate total annual lease payment

b 13. Calculate lease payment by lessor

b 14. Calculate lease payment return

c 15. ASPE capitalization criteria

d 16. Components of minimum lease payments

d 17. Interest/discount rate used by lessee

b 18. ASPE capitalization criteria

a 19. IFRS 16 finance lease exclusions

c 20. Identification of lease type for lessee

c 21. Identification of lease type for lessee

b 22. Identification of lease type for lessee

c 23. Calculate the PV of the lease payments

c 24. Identify incorrect statement

c 25. Lessee accounting for a capital (finance) lease

a 26. Depreciation of a leased asset by lessee

c 27. Items included in lease payments

d 28. Lease liability amortization

a 29. Determine reduction of lease obligation for lessee

c 30. Calculate interest expense and depreciation expense for lessee

c 31. Calculate depreciation expense for lessee

a 32. Calculate depreciation and interest expense for lessee

c 33. Calculate reduction of lease obligation for lessee

d 34. Calculate interest expense for lessee

a 35. Calculate depreciation expense for lessee

a 36. Calculate the lease liability of a lessee

d 37. Calculate the lease liability of a lessee

c 38. Calculate lease payment by lessor

a 39. Calculate annual least payment by lessor

a 40. Calculate lease payment by lessor

b 41. Effect on accounting of capital lease vs. operating lease

d 42. Capital versus operating leases

b 43. Capital versus operating leases

b 44. Expense recorded by lessee/operating lease

b 45. Calculate rent expense

d 46. Calculate rent expense with inducement

d 47. Calculate operating lease expense

Answer No. Description

c 48. Calculate operating lease income/expense

c 49. Disclosing obligations under leases

a 50. Right-of-use lease disclosures

c 51. Minimum lease payment disclosure

c 52. Objective of accounting for direct financing leases by lessor

a 53. Sales-type lease

d 54. Financing-type lease

b 55. Financing-type lease interest income

a 56. Financing-type lease receivable

a 57. Identification of lease type for lessor

a 58. Identification of lease type for lessor

d 59. Components of gross investment in lease

a 60. Recognition of unearned interest income

d 61. Lease receivable

a 62. Unearned interest income

b 63. Calculate gross profit for lessor

a 64. Calculate interest income for lessor

c 65. Calculate gross profit for lessor

a 66. Calculate interest income for lessor

d 67. Calculate lease receivable

a 68. Calculate income realized by lessor

c 69. Accounting for a sales-type lease (manufacturer or dealer lease)

a 70. Sales-type or Manufacturer/Dealer leases

d 71. Sales-type of Manufacture/Dealer leases

b 72. Direct/Indirect costs for Sales-type or Manufacturer/Dealer leases

d 73. Accounting for initial direct costs

c 74. Operating leases under ASPE

b 75. Operating leases under IFRS 16

b 76. Operating leases under IFRS 16

d 77. Revenues and expenses recorded by lessor/operating lease

a 78. Calculate income before taxes from operating lease.

d 79. Lease classification – ASPE vs IFRS 16

b 80. Discount rate used – ASPE vs IFRS 16

c *81. Gain/loss recognition in a sale-leaseback

d *82. Sale-leaseback transactions

d *83. Reporting gain on a sale-leaseback

a *84. Classification of lease of land

c *85. Classification of lease of land

b *86. Rent expense with sale-leaseback

b *87. Accounting for deferred profit in a sale-leaseback

b *88. Determine interest rate implicit in lease payments

a *89. Calculate lease-related expenses recognized by lessee

d *90. Determine long-term lease obligation for lessee

b *91. Lease-related income in sale-leaseback

*This topic is dealt with in an Appendix to the chapter.

EXERCISES

Item Description

E20-92 Types of lessors

E20-93 IFRS leases and how to account for them

E20-94 Initial direct costs and rental amounts

E20-95 Calculate lease payment by lessor

E20-96 Lessor accounting—sales-type lease

E20-97 Lease criteria under IFRS versus ASPE

E20-98 Bargain purchase option

E20-99 Discount rates

E20-100 Classification approach vs. contract-based approach

E20-101 Guaranteed versus unguaranteed residual values

E20-102 Capital lease amortization and journal entries

E20-103 Initial measurement of right-of-use asset and lease liability

E20-104 Difference between capital and operating leases under ASPE

E20-105 Operating lease calculations

E20-106 IFRS additional disclosures

E20-107 Risks and benefits of ownership

E20-108 Recording a Manufacturer/Dealer lease by the lessor

E20-109 Calculation of lease amounts for lessors for Manufacturer/Dealer leases with

unguaranteed residuals

E20-110 Calculation of lease amounts for lessors for Manufacturer/Dealer leases with

guaranteed residuals

E20-111 Operating lease journal entries for the lessor

E20-112 Differences between ASPE and IFRS 16

*E20-113 Lessee and lessor accounting (sale-leaseback)

*E20-114 Lessee and lessor accounting (sale-leaseback)

PROBLEMS

Item Description

P20-115 Lessee accounting—capital lease ASPE

P20-116 Lessee accounting—capital lease ASPE

P20-117 Lessee accounting – IFRS

P20-118 Lease accounting – IFRS

P20-119 Lease accounting—Lessee and Lessor—IFRS

P20-120 Manufacturer/Dealer or sales-type lease versus financing-type lease

P20-121 Lessor accounting—lease with IFRS criteria

*P20-122 Sale and leaseback

*This topic is dealt with in an Appendix to the chapter.

MULTIPLE CHOICE QUESTIONS

1. Why has accounting for leases been controversial?

a) Leasing is uncommon.

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

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

d) Most leases are immaterial.

Difficulty: Easy

Learning Objective: Understand the importance of leases from a business perspective.

Section Reference: Importance of Leases from a Business Perspective

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

2. Accounting for leases is important to all the following statements users except for

a) investors.

b) leasing companies.

c) financial institutions.

d) companies who purchase assets outright.

Difficulty: Easy

Learning Objective: Understand the importance of leases from a business perspective.

Section Reference: Importance of Leases from a Business Perspective

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

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

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

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

c) lease must contain a bargain purchase option.

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

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

4. Executory costs include

a) maintenance, interest and property taxes.

b) interest, property taxes and depreciation.

c) insurance, maintenance and property taxes.

d) maintenance, insurance and income taxes.

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Analytic

5. Company A is leasing equipment from Company B. Company B has quoted a total payment of $50,000 a month, which includes $2,000 a month for ongoing maintenance that will be provided by Company B. What is the executory cost of this transaction?

a) $50,000

b) $48,000

c) $2,000

d) $22,000

Difficulty: Medium

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

6. Which of the following is NOT a potential advantage of leasing?

a) no tax advantages for the lessor

b) cheaper financing

c) 100% financing at fixed rates

d) protection against obsolescence

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

7. Which of the following best describes current standards in accounting for leases under IFRS?

a) Leases are not capitalized.

b) Leases similar to instalment purchases are capitalized.

c) Only long-term leases are capitalized.

d) All leases are capitalized, unless the lease is considered a low value lease.

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

8. In Canada, lessors are usually these following types of companies, except for

a) manufacturer finance companies.

b) independent finance companies.

c) crown financings corporations.

d) traditional financial institutions.

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

9. The journal entries for a capitalized lease for the lessee include entries for all except

a) rent expense.

b) setting up the lease asset and liability.

c) depreciation of the asset.

d) interest paid on the lease.

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

10. What is NOT a key variable considered in deciding on the rate of return?

a) the lessee’s credit standing

b) the length of the lease

c) the status of the residual value (guaranteed or unguaranteed)

d) the type of asset being leased

Difficulty: Easy

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

11. On January 1, 2023, Jeckyll Ltd. signs an 8-year non-cancellable lease agreement to lease a storage building from Hyde Inc. Hyde is in the business of leasing/selling property. Collectability of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

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

2. At January 1, 2023, the fair value of the building is $1,350,000 and Hyde’s book value is $1,125,000.

3. The building has an estimated economic life of 8 years, with no residual value. Jeckyll uses straight-line depreciation for all its depreciable assets.

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

5. Jeckyll’s incremental borrowing rate is 10%. Hyde Inc. set the annual rental to ensure a 9% rate of return. The lessor’s implicit rate is known to Jeckyll.

6. The yearly lease payment includes $4,500 executory costs related to taxes on the property.

Rounded to the nearest dollar, the amount of the minimum annual lease payment is

a) $203,252.

b) $239,402.

c) $243,902.

d) $248,402.

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $1,350,000 ÷ 5.535 = $243,902 (PV of Ordinary Annuity Table)

12. On January 1, 2023, Jeckyll Ltd. signs an 8-year non-cancellable lease agreement to lease a storage building from Hyde Inc. Hyde is in the business of leasing/selling property. Collectability of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

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

2. At January 1, 2023, the fair value of the building is $1,350,000 and Hyde’s book value is $1,125,000.

3. The building has an estimated economic life of 8 years, with no residual value. Jeckyll uses straight-line depreciation for all its depreciable assets.

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

5. Jeckyll’s incremental borrowing rate is 10%. Hyde Inc. set the annual rental to ensure a 9% rate of return. The lessor’s implicit rate is known to Jeckyll.

6. The yearly lease payment includes $4,500 executory costs related to taxes on the property.

Rounded to the nearest dollar, the amount of the total annual lease payment is

a) $203,252.

b) $239,402.

c) $243,902.

d) $248,402.

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $243,902 + $4,500 = $248,402

13. Assume Red Corp. (a company reporting under IFRS) wants to earn an 4% return on its investment of $600,000 in an asset that is to be leased to Blue Corp. for ten years with an annual rental due in advance each year. How much should Red charge for annual rental assuming there is no purchase option that is reasonably certain to be exercised by Blue Corp.?

a) $172,073

b) $71,130

c) $73,974

d) $189,274

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $600,000 ÷ 8.4353 = $71,130 (PV of an Annuity Due Table)

14. Assume Red Corp. (a company reporting under IFRS) charges rent of $71,130 annually to Blue Corp. for the use of its asset. Red invested $600,000 in the asset that is to be leased to Blue Corp. for ten years with the annual rental due at the beginning of each year. Blue’s incremental borrowing rate is 6%. Assuming there is no purchase option that is reasonably certain to be exercised by Blue Corp, what is Red’s rate of implicit return on the investment?

a) 3.22%

b) 4.0%

c) 5.5%

d) 6.0%

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: BGN FV 0, PMT –71,130, N 10, PV 600,000, I/Y 4.0%

15. Which of the following is a correct statement regarding one of the ASPE capitalization criteria?

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

b) The lease must contain a bargain purchase option.

c) The lease term is 75% or more of the leased property’s estimated economic life.

d) The fair value of the minimum lease payments is equal to 90% or more of the present value of the leased asset.

Difficulty: Easy

Learning Objective: Identify and apply the factors that are used to determine if a contract is or contains a lease under IFRS and whether leases are capital or operating leases under the ASPE classification approach.

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

16. For a lessee, the minimum lease payments may include

a) the minimum rental payments and a guaranteed residual value only.

b) the minimum rental payments and a bargain purchase option only.

c) a bargain purchase option and a guaranteed residual value.

d) the minimum rental payments, a bargain purchase option, and a guaranteed residual value.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

17. In calculating the present value of the minimum lease payments, IFRS requires the lessee should

a) use its incremental borrowing rate in all cases.

b) use either its incremental borrowing rate or the interest rate implicit in the lease, whichever is higher.

c) use either its incremental borrowing rate or the interest rate implicit in the lease, whichever is lower.

d) use the interest rate implicit in the lease whenever this is reasonably determinable, otherwise use the lessee’s incremental borrowing rate.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

18. Which of the following is NOT a criteria to determine a capital lease under ASPE?

a) There is a bargain purchase option included in the lease.

b) The implicit interest rate in the lease is greater than the incremental borrowing rate.

c) The lease term is 75% or more of the leased property’s economic life.

d) The present value of the minimum lease payments is equal to 90% or more of the fair value of the leased asset.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

19. What type of lease may be EXCLUDED from being recognized as a capitalized lease under IFRS 16?

a) low value

b) vehicle leases

c) significant value leases

d) leases including bargain purchase options

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

20. Lease A does not contain a bargain purchase option, but the lease term is equal to 90% 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 85% of the estimated economic life of the leased property. Using ASPE criteria, how should the lessee classify these leases?

Lease A Lease B

a) Operating lease Capital lease

b) Operating lease Operating lease

c) Capital lease Capital lease

d) Capital lease Operating lease

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

21. On January 1, 2023, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectability of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

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

2. At January 1, 2023, the fair value of the building is $900,000 and Seline’s book value is $750,000.

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

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

5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne.

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

From the lessee's viewpoint, what type of lease is this?

a) sales-type lease

b) sale-leaseback

c) capital lease

d) operating lease

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

22. On January 1, 2023, Fern Corp. enters into an agreement with Nicki Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $543,244 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2023, is $1,400,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

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

4. Fern’s incremental borrowing rate is 10%. Fern does not have knowledge of the 8% implicit rate used by Nicki.

5. Immediately after signing the lease, Nicki discovers that Fern is the defendant in a lawsuit that is sufficiently material to make collectability of future lease payments doubtful.

From Fern’s viewpoint, what type of lease is this?

a) operating lease

b) finance lease

c) manufacturer or dealer lease

d) other finance lease

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $543,244 × 2.48685 = $1,350,966;
$1,350,966 / $1,400,000 = 96% > 90%

23. On January 1, 2023, Fern Corp. enters into an agreement with Nicki Rentals Inc. to lease a machine from Nicki Rentals. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $543,244 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2023, is $1,600,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

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

4. Fern’s incremental borrowing rate is 10%. Fern does not have knowledge of the 8% implicit rate used by Nicki.

From Fern’s perspective, what is the present value of the lease payments? (Round to the nearest whole number.)

a) $1,399 933

b) $1,512,011

c) $1,350,996

d) $1,486,043

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $543,244 × 2.48685 = $1,350,966

24. Regarding a basic capital (finance) lease for a lessee, which of the following statements is INCORRECT?

a) The lessee records the leased asset at the lower of the minimum lease payments and the fair value of the asset at the lease’s inception.

b) The lessee accounts for the lease as if an asset is purchased and a long-term obligation is entered into.

c) The lessor uses the lease as a source of funding.

d) The lessee uses the lease as a source of funding.

Difficulty: Easy

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

25. When a lessee is accounting for a capital (finance) lease

a) a guaranteed residual value is excluded from the “minimum lease payments.”

b) an unguaranteed residual value is included in the “minimum lease payments.”

c) a guaranteed residual value is basically an additional lease payment due at the end of the lease.

d) the present value of any guaranteed residual is deducted from the leased asset cost in determining the depreciable amount.

Difficulty: Easy

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

26. In calculating depreciation of a leased asset, the lessee should subtract a(n)

a) guaranteed residual value and depreciate over the term of the lease.

b) unguaranteed residual value and depreciate over the term of the lease.

c) guaranteed residual value and depreciate over the economic life of the asset.

d) unguaranteed residual value and depreciate over the economic life of the asset.

Difficulty: Easy

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

27. Which item is NOT included in amount of the lease payment under IFRS 16?

a) guaranteed residual values

b) renewal or purchase options

c) executory costs

d) contingent rentals

Difficulty: Easy

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

28. The lease liability under IFRS 16 is amortized using

a) the straight-line amortization method.

b) the discounted amortization method.

c) the present value interest method.

d) the effect interest method.

Difficulty: Easy

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

29. A lessee reported a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal

a) the current liability shown for the lease at the end of year 1.

b) the current liability shown for the lease at the end of year 2.

c) the reduction of the lease obligation in year 1.

d) one-tenth of the original lease liability.

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

30. On January 1, 2023, X-Man Corp. signed a ten-year non-cancellable lease for new machinery. The terms of the lease called for X-Man to make annual payments of $100,000 at the end of each year for ten years, with title to pass to X-Man at the end of the lease period. X-Man accordingly accounted for this lease transaction as a finance lease. The machinery has an estimated useful life of 15 years and no residual value. X-Man uses straight-line depreciation for all its property, plant and equipment. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. It was also determined that the fair value of the machinery on January 1, 2023 was $674,000.

With respect to this lease, for the year ending December 31, 2023, X-Man should report (rounded to the nearest dollar)

a) lease expense of $100,000, and depreciation expense of $44,734.

b) interest expense of $53,681 and depreciation expense of $67,101.

c) interest expense of $53,681 and depreciation expense of $44,734.

d) interest expense of $53,920 and depreciation expense of $44,933.

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $671,008 × .08 = $53,681; $671,008 ÷ 15 = $44,734

31. On January 1, 2023, Jeckyll Ltd. signs an 8-year non-cancellable lease agreement to lease a storage building from Hyde Inc. Hyde is in the business of leasing/selling property. Collectability of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

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

2. At January 1, 2023, the fair value of the building is $1,350,000 and Hyde’s book value is $1,125,000.

3. The building has an estimated economic life of 8 years, with no residual value. Jeckyll uses straight-line depreciation for all its depreciable assets.

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

5. Jeckyll’s incremental borrowing rate is 10%. Hyde Inc. set the annual rental to ensure a 9% rate of return. The lessor’s implicit rate is known to Jeckyll.

6. The yearly lease payment includes $4,500 executory costs related to taxes on the property.

Rounded to the nearest dollar, how much depreciation expense would Dionne record on this asset for calendar 2023?

a) $0

b) $108,000

c) $168,750

d) $140,625

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $1,350,000 ÷ 8 = $168,750

32. On July 1, 2023, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2023. Justin had purchased the equipment for $390,000 on January 1, 2023, and established a selling price of $500,000 (which was fair value at July 1, 2023). Assume that, at July 1, 2023, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years.

For the year ended December 31, 2023, and assuming that Trudeau uses straight-line depreciation, how much depreciation and interest expense should Trudeau record?

a) $18,750 and $15,516

b) $18,750 and $24,840

c) $22,500 and $15,516

d) $22,500 and $24,840

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $450,000 / 12 x 50% = $18,750
($450,000 – $62,100) × .08 X 6 / 12 = $15,516

33. On January 1, 2023, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2023, is $700,640. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

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

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

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

Assume the present value of the lease payments is $700,000 at January 1, 2023.

If Marlene accounts for this lease as a finance lease, what is the amount of the reduction in the lease obligation in calendar 2024? (Round to the nearest dollar.)

a) $201,622

b) $215,622

c) $221,784

d) $232,873

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $700,000 – [$271,622 – ($700,000 × .1)] = $498,378
$271,622 – ($498,378 × .1) = $221,784

34. On January 2, 2023, Cruise Ltd. signed a ten-year non-cancellable lease for a heavy-duty drill press. The lease required annual payments of $52,500, starting December 31, 2023, with title passing to Cruise at the end of the lease. Cruise is accounting for this lease as a capital (finance) lease. The drill press has an estimated useful life of 20 years, with no residual value. Cruise uses straight-line depreciation for all its plant assets. The lease payments were determined to have a present value of $352,279, based on an implicit interest rate of 8%.

On its 2023 income statement, how much interest expense should Cruise report in connection with this lease?

a) $0

b) $14,091

c) $42,000

d) $28,182

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $352,279 × .08 = $28,182

35. On January 2, 2023, Cruise Ltd. signed a ten-year non-cancellable lease for a heavy-duty drill press. The lease required annual payments of $52,500, starting December 31, 2023, with title passing to Cruise at the end of the lease. Cruise is accounting for this lease as a capital (finance) lease. The drill press has an estimated useful life of 20 years, with no residual value. Cruise uses straight-line depreciation for all its plant assets. The lease payments were determined to have a present value of $352,279, based on an implicit interest rate of 8%.

On its 2023 income statement, how much depreciation expense should Cambridge report in connection with this lease?

a) $17,614

b) $10,500

c) $21,000

d) $35,228

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $352,279 ÷ 20 = $17,614

36. On December 31, 2023, Eastern Inc. leased machinery with a fair value of $420,000 from Northern Rentals. The agreement is a six-year non-cancellable lease requiring annual payments of $80,000 beginning December 31, 2023. The lease is appropriately accounted for by Eastern as a finance lease. Eastern’s incremental borrowing rate is 11%; however, it also knows that the interest rate implicit in the lease payments is 10%. Eastern adheres to IFRS.

On its December 31, 2023 statement of financial position, Eastern should report a lease liability of (rounded to the nearest dollar)

a) $303,264.

b) $340,000.

c) $375,672.

d) $383,264.

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($80,000 × 4.7908) – $80,000 = $303,264

37. On December 31, 2022, Northern Skies Corp. leased a machine from Eastern Star Ltd. for a five-year period. Annual lease payments are $315,000 (including $15,000 annual executory costs), due on December 31 each year. The first payment was made on December 31, 2022, and the second payment on December 31, 2023. The appropriate interest rate for this type of lease is 10%. The present value of the minimum lease payments at the inception of the lease (before the first payment) was $1,251,000. The lease is being accounted for as a finance lease by Northern Skies. On its December 31, 2023 statement of financial position, Northern Skies should report a lease liability of

a) $951,000.

b) $936,000.

c) $855,900.

d) $746,100.

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $1,251,000 – $300,000 = $951,000 (2022)
$951,000 – [$300,000 – ($951,000 × .10)] = $746,100 (2023)

38. Frank Corporation has an asset with a fair market value of $400,000 that it wants to lease. Frank’s wants to recover its net investment in the leased asset and earn a 5% return. The asset will revert back to Frank’s at the end of a 5-year lease term. If Frank’s charges rent annually at the beginning of the year, what should amount should the annual rent be (rounded to whole dollars)?

a) $20,000

b) $21,997

c) $87,989

d) $92,400

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $400,000 ÷ 4.5460 = $87,989 (PV of an Annuity Due Table)

39. Frank Corporation has an asset that cost $425,000 with a fair market value of $400,000 that it wants to lease. Frank wants to recover its net investment in the leased asset and earn a 5% return. The asset will revert back to Frank’s at the end of a 5-year lease term. What is the difference in the annual payment Frank would receive if Frank charged rent at the end of the year rather than at the beginning of the year? (Round to whole dollars.)

a) $4,400 more annually

b) $4,400 less annually

c) $4,675 more annually

d) $4,675 less annually

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $400,000 ÷ 4.5460 = $87,989 (PV of an Annuity Due Table);

$400,000 ÷4.3295 = $92,389; $92,389 – $87,989 = $4,400 more

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

a) $51,745

b) $62,096

c) $101,200

d) $104,367

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $450,000 – ($20,000 x 0.67556) = $436,489;

$436,489 ÷ 8.43533 = $51,745 (PV of $table and PV of an Annuity Due Table)

41. In the earlier years of a lease, from the lessee's perspective, accounting for a leased asset as

a) a capital lease will enable the lessee to report higher income in the earlier years, compared to accounting for it as an operating lease.

b) a capital lease will cause debt to increase, compared to accounting for it as an operating lease.

c) an operating lease will cause income to decrease in the earlier years, compared to accounting for it as a finance lease.

d) an operating lease will cause debt to increase, compared to accounting for it as a finance lease.

Difficulty: Easy

Learning Objective: Account for operating leases by lessees under ASPE (and short-term leases and low-value leases under IFRS 16) and compare the operating and capitalization methods of accounting for lessees.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

42. Which statement is CORRECT in comparing capital leases to operating leases?

a) A capital lease will have a higher asset turnover compared to an operating lease.

b) A capital lease will increase the return on total assets compared to an operating lease.

c) A capital lease will have a lower debt-to-equity ratio compared to an operating lease.

d) A capital lease will have a higher debt-to-equity ratio compared to an operating lease.

Difficulty: Easy

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

43. A capital lease, as compared to an operating lease, has a higher likelihood of which of the following?

a) default payment

b) violation of loan covenants

c) stronger ratios

d) higher overall expenses

Difficulty: Easy

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

44. On January 1, 2023, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

2. The fair value of the machine on January 1, 2023, is $700,000. The machine has a remaining economic life of 10 years, with no residual value. The machine reverts to the lessor upon the termination of the lease.

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

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

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

If Marlene accounts for the lease as an operating lease, what expense(s) will be reported in calendar 2023 in relation to this lease?

a) Depreciation Expense

b) Rent Expense

c) Interest Expense

d) Depreciation Expense and Interest Expense

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

45. On December 1, 2023, Greens Corp. leased office space for 10 years at a monthly rental of $40,000, under an operating lease. On that date Greens paid the landlord the following amounts:

Rent deposit $40,000

First month's rent 40,000

Last month's rent 40,000

Installation of new walls and offices 150,000

$270,000

Greens debited the entire $270,000 payment to Prepaid Rent.

How much should Greens Corp recognize as rent expense for the year ended December 31, 2023?

a) $40,000

b) $41,250

c) $27,000

d) $154,000

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $40,000 + [($150,000 / 10) x 1 ÷ 12] = $41,250

46. Laurel Ltd. leased an office building to Hardy Inc. for a three-year, non-renewable term. This was properly classified as an operating lease by both parties. The monthly rental is set at $12,000 per month. However, as an added inducement, Laurel agreed to grant Hardy a four-month rent-free period at the beginning of the lease, and a further two-month rent-free period at the end of the lease. How much rent expense should Hardy record each month during the three-year period?

a) $12,000

b) $11,250

c) $10,667

d) $10,000

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($12,000 x 30) ÷ 36 = $10,000

47. On May 1, 2023, Charles Corp. leased equipment to Darwin Inc. for one year under an operating lease. Instead of leasing it, Darwin could have bought the equipment from Charles for $800,000 cash. At this time, Charles's accounting records showed a book value for the equipment of $700,000. Depreciation on the equipment in 2023 was $90,000. During 2023, Darwin paid $22,500 per month rent to Charles for the 8-month period, and Charles incurred maintenance and other related costs under the terms of the lease of $16,000.

The pre-tax expense reported by Darwin from this lease for the year ended December 31, 2023, should be

a) $74,000.

b) $90,000.

c) $164,000.

d) $180,000.

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $22,500 x 8 = $180,000

48. On July 1, 2022, Huey Corp. leased heavy equipment to Duey Inc. for one year, at $60,000 a month. Duey returned the equipment on June 30, 2023, and the next day, Huey Corp. leased this equipment to Luey Ltd. for three years, at $75,000 a month. The original cost of the equipment was $3,200,000. The equipment, which has been continually on lease since July 1, 2020, is being depreciated on a straight-line basis over ten years with no residual value.

Assuming that both the lease to Duey and the lease to Luey are appropriately recorded as operating leases for accounting purposes, how much net income (loss) before income taxes that each company would record as a result of the above facts for the year ended December 31, 2023?

Huey Duey Luey

a) $810,000 $(360,000) $(450,000)

b) $450,000 $(450,000) $(360,000)

c) $490,000 $(360,000) $(450,000)

d) $490,000 $(360,000) $(900,000)

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Huey: ($60,000 × 6) + ($75,000 × 6) – ($3,200,000 ÷ 10) = $490,000
Duey: ($60,000) × 6 = $(360,000)
Luey: ($75,000) × 6 = $(450,000)

49. Obligations under leases should be disclosed as

a) all current liabilities.

b) all noncurrent liabilities.

c) the current portion in current liabilities and the remainder in noncurrent liabilities.

d) deferred credits.

Difficulty: Easy

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

50. Under IFRS 16, the right-of-use lease requires similar disclosure to which statement of financial position items?

a) long-term liabilities

b) common shares

c) investments

d) interest payable

Difficulty: Easy

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

51. How many years do companies have to disclose the minimum lease payments in the leases note disclosure?

a) 1

b) 2

c) 5

d) 10

Difficulty: Easy

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

52. For companies engaged in direct financing leases (ASPE) or finance leases (IFRS),

a) they are generally manufacturers or retail stores.

b) their profits are derived from leasing their inventory at a profit.

c) their objective is to earn interest income on the financing arrangement with the lessee.

d) such leases are frequently operating leases.

Difficulty: Easy

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

53. Under ASPE, a lease in which the lessor wants to include a profit in the rental amount as well as the asset cost is called a

a) sales-type lease.

b) manufacturer lease.

c) direct financing lease.

d) finance lease.

Difficulty: Easy

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

54. Under IFRS 16, a lease in which the lessor is involved in mostly financing operations, such as lease-finance companies is called a

a) sales-type lease.

b) manufacturer lease.

c) direct financing lease.

d) finance lease.

Difficulty: Easy

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

55. A lease financing company will purchase an asset and then lease it to another entity in order to earn interest income. If an asset costs the financing company $500,000 (fair value), and the asset is leased out on January 1^st, what is the interest income to be recognized at the end of the first year on December 31^st if the financing company has an implicate rate of 6%?

a) Can not be determined.

b) $30,000

c) $500,000

d) The lease payments received in the first year.

Difficulty: Medium

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Since it’s the 1^st year, FV of the asset $500,000 x 6% = $30,000

56. A lease financing company will purchase an asset and then lease it to another entity in order to earn interest income. If an asset costs the financing company $500,000 (fair value), and the asset is leased out on January 1^st, at a lease payment of $9,500 per month for 60 months, what is the lease receivable that the financing company will record at the inception of the lease?

a) $570,000

b) $500,000

c) $9,500

d) $114,000

Difficulty: Medium

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $9,500 x 60 = $570,000

57. On January 1, 2023, Dionne Ltd. signs a 10-year non-cancellable lease agreement to lease a storage building from Seline Inc. Seline is in the business of leasing/selling property. Collectability of the lease payments is reasonably assured and no additional costs are to be incurred by the lessor (other than executory costs). Both the lessor and the lessee are private corporations adhering to ASPE. The following information is available regarding this lease agreement:

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

2. At January 1, 2023, the fair value of the building is $900,000 and Seline’s book value is $750,000.

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

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

5. Dionne's incremental borrowing rate is 11%. Seline Inc. set the annual rental to ensure a 10% rate of return. The lessor’s implicit rate is known to Dionne.

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

From the lessor's viewpoint, what type of lease is this?

a) sales-type lease

b) sale-leaseback

c) direct financing lease

d) operating lease

Difficulty: Medium

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: FV exceeds cost (profit element)

58. On January 1, 2023, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

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

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

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

From Dietrich’s viewpoint, what type of lease is this?

a) operating lease

b) finance lease

c) manufacturer or dealer lease

d) other finance lease

Difficulty: Medium

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: Fails to meet all requirements for lessor

59. For a lessor, which of the following would NOT be included in the Gross Investment in Lease (Lease Receivable)?

a) guaranteed residual value

b) unguaranteed residual value

c) bargain purchase option

d) executory costs

Difficulty: Easy

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

60. In a lease that is appropriately recorded as a direct financing lease (ASPE) or finance lease (IFRS) by the lessor, the unearned interest income is

a) amortized and taken into income over the lease term using the effective interest method.

b) amortized and taken into income over the lease term using the straight-line method.

c) taken into income at the inception of the lease.

d) taken into income at the end of the lease.

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

61. For the lessor, what is included in the lease receivable account?

a) the discounted lease payments less any guaranteed or unguaranteed residual value or any bargain purchase option

b) the discounted lease payments plus any guaranteed or unguaranteed residual value or any bargain purchase option

c) the undiscounted lease payments minus any guaranteed or unguaranteed residual value or any bargain purchase option

d) the undiscounted lease payments plus any guaranteed or unguaranteed residual value or any bargain purchase option

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

62. For the lessor, what is included in the Unearned Interest Income account?

a) the difference between the lease receivable and the fair value of the leased property

b) the lease receivable plus the fair value of the leased property

c) the difference between the lease receivable and the interest expected to be earned

d) the lease receivable plus the interest expected to be earned

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

63. On July 1, 2023, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2023. Justin had purchased the equipment for $390,000 on January 1, 2023, and established a selling price of $500,000 (which was fair value at July 1, 2023). Assume that, at July 1, 2023, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years.

For the year ended December 31, 2023, what is the amount of gross profit that Justin should record regarding this lease?

a) $0

b) $60,000

c) $110,000

d) $231,000

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $450,000 – $390,000 = $60,000

64. On July 1, 2023, Justin Ltd., a dealer in machinery and equipment, leased equipment to Trudeau Inc. The lease is for ten years, and at the end of the lease period, title will pass to Trudeau. Justin requires ten equal annual payments of $62,100 on July 1 of each year, and Trudeau made the first payment on July 1, 2023. Justin had purchased the equipment for $390,000 on January 1, 2023, and established a selling price of $500,000 (which was fair value at July 1, 2023). Assume that, at July 1, 2023, the present value of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $450,000. The useful life of the equipment is 12 years.

For the year ended December 31, 2023, what is the amount of interest income that Justin should record regarding this lease?

a) $15,516

b) $13,116

c) $17,516

d) $24,840

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($450,000 – $62,100) × .08 X 6 / 12 = $15,516

65. On July 1, 2023, Nickel Ltd. leases equipment from Dime Corp., under an eight-year capital (finance) lease. Equal annual payments of $100,000 are required, payable on July 1 of each year. The first payment is made on July 1, 2023. The appropriate rate of interest for this lease is 9%, and title will transfer to Nickel at the end of the lease contract. The fair value of the equipment is $620,000 and the cost in Dime's accounting records is $550,000. The present value of the lease payments is $620,637.

What is the amount of gross profit and interest income that Dime would record for the year ended December 31, 2023?

a) $(637)

b) $0

c) $70,000

d) $70,637

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $620,000 – $550,000 = $70,000

66. On July 1, 2023, Nickel Ltd. leases equipment from Dime Corp., under an eight-year capital (finance) lease. Equal annual payments of $100,000 are required, payable on July 1 of each year. The first payment is made on July 1, 2023. The appropriate rate of interest for this lease is 9%, and title will transfer to Nickel at the end of the lease contract. The fair value of the equipment is $620,000 and the cost in Dime's accounting records is $550,000. The present value of the lease payments is $620,637.

What is the amount of gross profit and interest income that Dime would record for the year ended December 31, 2023?

a) $23,400

b) $20,250

c) $36,000

d) $46,800

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($620,000 – $100,000) × .09 X 6/12 = $23,400

67. On January 1, 2023, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

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

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

If Dietrich records this lease as a finance lease, what amount would be recorded as Lease Receivable at the inception of the lease?

a) $271,622

b) $675,483

c) $700,000

d) $814,866

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $271,622 × 3 = $814,866

68. Cary Corp. manufactures equipment for sale or lease. On December 31, 2023, Cary leased equipment to Grant Sales Inc. for five years, with ownership of the equipment being transferred to Grant at the end of the lease. Annual lease payments are $252,000 (including $12,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2023. Collectability of the remaining lease payments is reasonably assured, and there are no additional costs (other than executory costs) to be incurred by Cary. The normal sales price of the equipment (fair value) is $924,000, and Cary’s cost is $720,000. The present value of the lease payments is equal to the fair value of the equipment.

For the year ended December 31, 2023, what amount of income should Cary report from this lease?

a) $204,000

b) $264,000

c) $276,000

d) $396,000

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $924,000 – $720,000 = $204,000

69. For a sales-type lease (ASPE) or manufacturer or dealer lease (IFRS),

a) the sales price includes the present value of the unguaranteed residual value.

b) the present value of the guaranteed residual value is deducted to determine the cost of goods sold.

c) the gross profit will be the same whether the residual value is guaranteed or unguaranteed.

d) cost of goods sold is not recognized.

Difficulty: Easy

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

70. For a sales-type lease (ASPE) or manufacturer or dealer lease (IFRS),

a) the sales price and cost of goods sold are only recognized for the portion of the asset that is sure to be realized.

b) the sales price and cost of goods sold are recognized on the entire asset including unguaranteed residuals.

c) the present value of the guaranteed residual value is deducted to determine the cost of goods sold.

d) the present value of the guaranteed residual value is added to determine the cost of goods sold.

Difficulty: Easy

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

71. Mord Inc. produces vehicles and considers itself in the business of manufacturing-type leases, in addition to simply selling the vehicle. If a vehicle that Mord sells retails for $50,000, is produced at a cost of $35,000, but is leased rather than sold, what is the amount of gross profit that is realized upon the sale of this vehicle. Assume that due to the residual, only 90% of the gross profit will be realized.

a) $50,000

b) $35,000

c) $15,000

d) $13,500

Difficulty: Medium

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($50,000 – $35,000) x 90% = $13,500

72. For a sales-type lease (ASPE) or manufacturer or dealer lease (IFRS),

a) direct costs are recognized over the term of the lease.

b) direct costs are recognized as an expense in the year they are incurred.

c) direct costs are treated identically under ASPE and IFRS.

d) direct costs treatment does not apply the matching concept.

Difficulty: Easy

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

73. Initial direct costs are

a) costs incurred by a lessee that are directly associated with negotiating and arranging a lease.

b) expensed in the year of incurrence by the lessor in a financing-type lease.

c) spread over the term of a sales-type lease by the lessee.

d) deferred and allocated over the term of an operating lease in proportion to the amount of rental (lease) income that is recognized.

Difficulty: Easy

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

74. When is a lease recognized as an operating lease under ASPE?

a) if it is of low value to the corporation

b) if it is less than one year

c) if it doesn’t meet the criteria of a capital lease

d) if the company elects to record as an operating lease

Difficulty: Easy

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

75. When is a lease recognized as an operating lease under IFRS?

a) if it is deemed so by the lessor

b) if it is less than one year

c) if it doesn’t meet the criteria of an operating lease

d) if the company elects to record as an operating lease

Difficulty: Easy

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

76 When is a lease recognized as an operating lease under IFRS?

a) if it is deemed so by the lessor

b) if it is a small amount

c) if it doesn’t meet the criteria of an operating lease

d) if the company elects to record as an operating lease

Difficulty: Easy

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

77. On January 1, 2023, Marlene Corp. enters into an agreement with Dietrich Rentals Inc. to lease a machine from them. Both corporations adhere to ASPE. The following data relate to the agreement:

1. The term of the non-cancellable lease is three years with no renewal option. Payments of $271,622 are due on December 31 of each year.

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

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

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

If Dietrich accounts for the lease as an operating lease, what revenue(s) and/or expense(s) will be reported in calendar 2023 in relation to this lease?

a) Rental Revenue

b) Interest Income

c) Interest Expense and Depreciation Expense

d) Rental Revenue and Depreciation Expense

Difficulty: Medium

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

78. On May 1, 2023, Charles Corp. leased equipment to Darwin Inc. for one year under an operating lease. Instead of leasing it, Darwin could have bought the equipment from Charles for $800,000 cash. At this time, Charles's accounting records showed a book value for the equipment of $700,000. Depreciation on the equipment in 2023 was $90,000. During 2023, Darwin paid $22,500 per month rent to Charles for the 8-month period, and Charles incurred maintenance and other related costs under the terms of the lease of $16,000.

The net income before income taxes reported by Charles from this lease for the year ended December 31, 2023, should be

a) $74,000.

b) $90,000.

c) $164,000.

d) $180,000.

Difficulty: Medium

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($22,500 x 8) – $16,000 – $90,000 = $74,000

79. Under ASPE, leases are either capital or an operating lease to a lessee; under IFRS 16,

a) leases are treated the same as under ASPE.

b) all leases are considered operating.

c) all leases are considered capital.

d) all leases are considered capital except for short-term leases and leases of low-value assets.

Difficulty: Easy

Learning Objective: Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

80. Under IFRS 16, the lessee uses the rate implicit in the lease to calculate leases; under ASPE,

a) the same treatment is used.

b) the lower of the lessee’s incremental borrowing rate and the rate implicit in the lease is used.

c) the higher of the lessee’s incremental borrowing rate and the rate implicit in the lease is used.

d) the incremental borrowing rate is used.

Difficulty: Easy

Learning Objective: Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

*81. If a corporation adhering to IFRS sells machinery at fair value and then leases it back (sale-leaseback) as a finance lease, any gain on the sale should be

a) recognized in the year of “sale.”

b) recorded as other comprehensive income.

c) deferred and amortized to income over the term of the lease.

d) deferred and recognized as income at the end of the lease.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*82. A sale-leaseback transaction is

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

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

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

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

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

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

a) operating income.

b) other comprehensive income.

c) a separate component of shareholders' equity.

d) a deferred gain.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

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

a) operating lease.

b) capital lease.

c) sales-type lease.

d) direct-financing lease.

Difficulty: Easy

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

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

a) operating lease.

b) capital lease.

c) sales-type lease or financing lease.

d) rental agreement.

Difficulty: Easy

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

*86. On June 30, 2023, Sharma Corp. sold equipment for its fair value of $300,000. The equipment had a book value of $500,000 and a remaining useful life of 10 years. The same day, Sharma leased back the equipment at $6,000 per month for 5 years with no option to renew the lease or repurchase the equipment.

Sharma's equipment rent expense for this equipment for the year ended December 31, 2023, should be

a) $72,000.

b) $36,000.

c) $30,000.

d) $24,000.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $6,000 × 6 = $36,000

*87. On December 31, 2023, Lewis Ltd. sold a machine to Martin Inc. and simultaneously leased it back for one year. Pertinent information at this date follows:

Sales price $180,000

Book value of machine 165,000

Present value of reasonable lease rentals

($1,500 for 12 months @ 12%) 16,883

Machine’s estimated remaining useful life 12 years

On Lewis’s December 31, 2023 statement of financial position, the deferred profit from the sale of this machine should be reported as

a) $17,000.

b) $15,000.

c) $2,000.

d) $0.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $180,000 – $165,000 = $15,000

*88. Ball Ltd. purchased land and constructed a service station, at a total cost of $450,000. On January 2, 2022, when construction was completed, Ball sold the service station and land to a major oil company for $500,000, and immediately leased it back from the oil company. Fair value of the land at the time of the sale was $50,000. The lease is a 10-year, non-cancellable lease. Ball uses straight-line amortization for its other assets. The economic life of the station is 15 years with zero residual value. Title to the property will revert back to Ball at the end of the lease. A partial amortization schedule for this lease follows:

Payments Interest Amortization Balance

Jan 02, 2022 $500,000.00

Dec 31, 2022 $81,372.66 $50,000.00 $31,372.66 468,627.34

Dec 31, 2023 81,372.66 46,862.74 34,509.92 434,117.42

Dec 31, 2024 81,372.66 43,411.74 37,960.92 396,156.50

What is the interest rate implicit in the amortization schedule presented above?

a) 12%

b) 10%

c) 8%

d) 6%

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

Feedback: $50,000 ÷ $500,000 = 10%

AACSB: Analytic

*89. Ball Ltd. purchased land and constructed a service station, at a total cost of $450,000. On January 2, 2022, when construction was completed, Ball sold the service station and land to a major oil company for $500,000, and immediately leased it back from the oil company. Fair value of the land at the time of the sale was $50,000. The lease is a 10-year, non-cancellable lease. Ball uses straight-line amortization for its other assets. The economic life of the station is 15 years with zero residual value. Title to the property will revert back to Ball at the end of the lease.

Payments Interest Amortization Balance

Jan 02, 2022 $500,000.00

Dec 31, 2022 $81,372.66 $50,000.00 $31,372.66 468,627.34

Dec 31, 2023 81,372.66 46,862.74 34,509.92 434,117.42

Dec 31, 2024 81,372.66 43,411.74 37,960.92 396,156.50

The total lease-related expenses recognized by the lessee during 2023 are (rounded to the nearest dollar)

a) $76,863.

b) $80,000.

c) $81,373.

d) $91,863.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: [($500,000 – $50,000) ÷ 15] + $46,863 = $76,863

*90. Ball Ltd. purchased land and constructed a service station, at a total cost of $450,000. On January 2, 2022, when construction was completed, Ball sold the service station and land to a major oil company for $500,000, and immediately leased it back from the oil company. Fair value of the land at the time of the sale was $50,000. The lease is a 10-year, non-cancellable lease. Ball uses straight-line amortization for its other assets. The economic life of the station is 15 years with zero residual value. Title to the property will revert back to Ball at the end of the lease.

Payments Interest Amortization Balance

Jan 02, 2022 $500,000.00

Dec 31, 2022 $81,372.66 $50,000.00 $31,372.66 468,627.34

Dec 31, 2023 81,372.66 46,862.74 34,509.92 434,117.42

Dec 31, 2024 81,372.66 43,411.74 37,960.92 396,156.50

What is the amount of the lessee's obligation to the lessor after the December 31, 2022 payment? (Round to the nearest dollar.)

a) $500,000

b) $468,627

c) $434,117

d) $396,157

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: $396,157 (See amortization table.)

*91. Ball Ltd. purchased land and constructed a service station, at a total cost of $450,000. On January 2, 2022, when construction was completed, Ball sold the service station and land to a major oil company for $500,000, and immediately leased it back from the oil company. Fair value of the land at the time of the sale was $50,000. The lease is a 10-year, non-cancellable lease. Ball uses straight-line amortization for its other assets. The economic life of the station is 15 years with zero residual value. Title to the property will revert back to Ball at the end of the lease. A partial amortization schedule for this lease follows:

Payments Interest Amortization Balance

Jan 02, 2022 $500,000.00

Dec 31, 2022 $81,372.66 $50,000.00 $31,372.66 468,627.34

Dec 31, 2023 81,372.66 46,862.74 34,509.92 434,117.42

Dec 31, 2024 81,372.66 43,411.74 37,960.92 396,156.50

The total lease-related income recognized by the lessee during 2023 is

a) $0.

b) $5,000.

c) $3,333.

d) $50,000.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Feedback: ($500,000 – $450,000) ÷ 10 = $5,000

EXERCISES

Ex. 20-92 Types of lessors

Explain the difference between a manufacturer finance company and an independent finance company.

Solution 20-92

A manufacturer finance company, also called a captive leasing company, is a subsidiary whose main business is to provide leasing services for a parent company. Examples are General Motors Acceptance Company of Canada (GMAC), which provides lease financing for General Motors dealers, and Chrysler Finance Service Canada, which provides lease financing for Chrysler dealers.

An independent finance company, on the other hand, acts as financial intermediary by providing lease financing for a wide range of manufacturers, distributors and other dealers. The dealer will sell the customer the product(s) and then outsource the financing to an independent finance company. This is commonly seen in the construction industry.

Difficulty: Easy

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 20-93 IFRS leases and how to account for them

a) Under IFRS 16 what are leases classified as and how are they accounted for?

b) What are the two exceptions to this standard?

c) Provide an example of the journal entries used when accounting for a Capital lease for both the lessee and lessor.

Solution 20-93

a) All leases use the contract-based approach and are classified as capitalized leases. The contract-based approach is based on the view that “lease contracts create assets and liabilities that should be recognized in the financial statements of lessee”.

b) The two exceptions to capitalizing leases are short-term leases and leases for low-value items.

Lessee:

Dr. Equipment under Lease

Cr. Obligations under Lease

Dr. Depreciation Expense

Cr. Accumulated Depreciation

Obligation under Lease:

Dr. Interest Expense

Cr. Cash

Lessor:

Dr. Lease Receivable

Cr. Equipment

Dr. Cash

Cr. Interest Income

Cr. Lease Receivable

Difficulty: Medium

Learning Objective: Explain the conceptual nature, economic substance, and advantages of lease transactions.

Section Reference: The Leasing Environment

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-94 Initial direct costs and rental amounts

a) Identify the types of initial direct costs that are incurred by the lessor and provide three examples of these costs.

b) Explain how a lessor determines a rental amount to charge in a lease arrangement.

Solution 20-94

a) The initial direct costs are generally defined as costs incurred by a lessor that are directly associated with negotiating and arranging a specific lease. These costs are included in the amount invested in the lease to be recovered by the lessor. Examples of such costs are commissions, legal fees, and costs of preparing and processing lease documents.

b) The lessor determines the rental amount to charge a lessee based on the rate of return—the implicit rate—that the lessor needs to receive in order to justify leasing the asset. The key variables considered in deciding on the rate of return are the lessee’s credit standing, the length of the lease, and the status of the residual value (guaranteed or unguaranteed).

Difficulty: Easy

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 20-95 Calculate lease payment by lessor

Howdy Corporation (a private company using ASPE) has a $500,000 piece of machinery that its wants to lease to Doody Corporation. Howdy wants to earn a 9% return on its lease. The machinery will be leased for 7 years and the annual rental payment will be due at the beginning of each year. The lease doesn’t include a bargain purchase option or residual value at the end of the lease.

Instructions

a) Calculate the annual lease payment Howdy Corporation should charge to Doody Corporation.

b) CRITICAL THINKING: Why would a company officer a 0% financing lease, like those advertised by car dealerships? Does 0% financing actually exist or are there hidden costs associated with the lease? If so, provide examples.

Solution 20-95

Investment to be recovered $500,000

Less: PV of BPO or residual value at end of lease 0

PV to be recovered through the lease payments $500,000

Seven beginning-of-the-year lease payments to yield a 9% return:

($500,000 ÷ 5.48592*) $91,142.42

*PV of an annuity due (Table A-5); i=9%, n=7

b) CRITICAL THINKING: Typically, car dealerships have hidden costs or upfront payments required in order to qualify for 0% financing. The upfront payments can include freight costs and pre-delivery expenses, plus taxes on these items. Normally, an initial down payment on the car and the first month’s rental payment is required in advance. Customers may also be charged an administration fee for acquiring the vehicle and processing the paperwork.

The price of the car typically includes an interest charge since a lower price purchase price may be negotiated rather than leasing at 0% financing. The hidden costs and the hidden interest included in the price of the car could be more than the cost of borrowing money elsewhere to purchase the car.

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-96 Lessor accounting—sales-type lease

Albert Corp., a private corporation that adheres to ASPE, is a manufacturer of truck trailers. On January 1, 2023, Albert leases ten trailers to Einstein Inc. under a six-year non-cancellable lease agreement. The following information about the lease and the trailers is provided:

1. Equal annual payments (due on December 31 each year) will be payable, to provide Albert with an 8% return on their investment.

2. Title to the trailers will pass to Einstein at the end of the lease.

3. At January 1, 2023, the fair value of each trailer is $50,000. The cost of each trailer to Albert Corp. is $45,000. Each trailer has an expected useful life of nine years.

4. Collectability of the lease payments is reasonably assured, and any non-reimbursable costs under the lease that are likely to be incurred by Albert can be reasonably estimated.

Instructions

a) Identify and explain what type of lease this is for the lessor.

b) Calculate the annual lease payment. Present value factor for 6 periods at 8% is 4.62288. Round to the nearest dollar.

c) Prepare a lease amortization schedule for Albert Corp. for the first three years.

d) Prepare the journal entries for the lessor for 2023 and 2024 to record the lease agreement, the receipt of the lease rentals, and the recognition of income. Assume the use of a perpetual inventory system and round all amounts to the nearest dollar.

Solution 20-96

a) This is a sales-type lease to the lessor, Albert Corp. Albert's gross profit on this sale is $50,000, which is recognized in the year of sale (2023). It is not an operating lease because title to the assets passes to the lessee, the present value ($500,000) of the minimum lease payments equals or exceeds 90% ($450,000) of the fair value of the leased trailers, collectability is reasonably assured, and any reimbursable costs under the lease that are likely to be incurred can be reasonably estimated.

b) ($50,000 × 10) ÷ 4.62288 = $108,158 or

6 N 8 i 500000 PV CPT PMT => $108,158

c) Lease Amortization Schedule (ALBERT CORP.)

Net

Annual Interest on Investment Net

Date Lease Rental Net Investment Recovery_ Investment

1/1/23 $500,000

12/31/23 $108,158 $40,000 $68,158 431,842

12/31/24 108,158 34,547 73,611 358,231

12/31/25 108,158 28,658 79,500 278,731

Jan 1, 2023

Lease Receivable ($108,158 x 6) 648,948

Cost of Goods Sold 450,000

Sales Revenue 500,000

Inventory 450,000

Unearned Interest Income 148,948

Dec 31, 2023

Cash 108,158

Lease Receivable 108,158

Unearned Interest Income 40,000

Interest Income 40,000

Dec 31, 2024

Cash 108,158

Lease Receivable 108,158

Unearned Interest Income 34,547

Interest Income 34,547

Difficulty: Medium

Learning Objective: Calculate the lease payment that is required for a lessor to earn a specific return.

Section Reference: Determination of Rental Payments

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-97 Lease criteria under IFRS versus ASPE

a) Identify and explain the cited by IFRS 16 to support classifying a lease as a finance lease.

b) How do these criteria differ from ASPE? What criteria must be used to classify a lease as a direct financing of sales type lease?

Solution 20-97

a) Under IFRS 16 companies must assess whether each contract they enter into is (or contains) a lease. “A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration” (IFRS 16.9).

While the goal was initially to recognize assets and liabilities for the rights and obligations of all leases, exceptions are recognized in IFRS 16 for short-term leases of 12 months or less, and for leases where the underlying asset is of low-value.

b) In order for a lessor to classify a lease as a direct financing or a sales-type lease under ASPE, the lease at the date of inception must satisfy one or more of the following Group I criteria (a, b, and c) and both of the following Group II criteria (a and b):

Group I

a) There is reasonable assurance that the lessee will obtain ownership of the property at the end of the lease term.

b) The lease term is equal to 75% or more of the estimated economic life of the leased property.

c) The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property.

Group II

a) Collectability of the payments required from the lessee is reasonably assured.

b) Any non-reimbursable costs under the lease that are likely to be incurred by the lessor can be reasonably estimated.

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-98 Bargain purchase option

Star Company (a private company that reports under ASPE) leases a piece of equipment for $2,500 per month for 30 months with an option to purchase the equipment for $10,000 at the end of the 30-month period.

Instructions

a) If the equipment’s estimated fair market value is $40,000 at the end of the 30 months, is this considered a bargain purchase option?

b) Explain why or why not.

Solution 20-98

a) Star Co. can purchase the equipment at the end of the lease for $10,000 when the estimated fair market value is $40,000. The fair market value would be considered significantly higher than the purchase price option and it can be assumed that the option is a bargain and will be acted on.

b) A bargain purchase option is a provision that allows the lessee to purchase the leased asset for a price that is significantly lower than the asset’s expected fair value when the lessee can exercise this option.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

Ex 20-99 Discount rates

For the lessee discuss what discount rates should be used and the rationale behind the rate for ASPE and IFRS.

Solution 20-99

For ASPE, the lower of the interest rate implicit in the lease and the incremental borrowing rate should be used to calculate the present value of the minimum lease payments. The lesser of the two rates helps to ensure that the lessee does not use an artificially high incremental borrowing rate that would cause the present value of the minimum lease payments to be less than 90% of the property’s fair value, making it an operating versus capital lease.

Under IFRS, the interest rate implicit in the lease is to be used whenever reasonably determinable; otherwise, the incremental borrowing rate is used for present value calculations. The lessor’s implicit rate is generally a more realistic rate to use in determining the amount to report as the asset and related liability for the lessee.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

Ex. 20-100 Classification approach vs. contract-based approach

Explain the difference between classification approach vs contract-based approach for capitalizing leases.

Solution 20-100

The classification approach says that transactions should be classified and accounted for according to its economic substance. This would justify capitalizing leases that have similar characteristics to instalment purchases.

On the other hand, the contract-based approach (also called a right-of-use approach) views the lease as conveying a contractual right to use the property (not the physical property itself). This approach would justify capitalizing the fair value of the rights and obligations of just about all leases, even those currently accounted for as operating leases. Exceptions would be leases that actually transfer control of the asset or almost all of the risks and benefits associated with ownership, such as leases where title will transfer at the end of the contract, or where there is a bargain purchase option.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

CPA: Commuinication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 20-101 Guaranteed versus unguaranteed residual values

Explain the difference between a guaranteed residual value (expected to be payable by the lessee under residual value guarantees) and an unguaranteed residual value and the economic and accounting consequences of using a guaranteed residual value in a lease arrangement.

Solution 20-101

The guaranteed residual value from the lessee’s perspective is the maximum amount the lessor can require the lessee to pay at the end of the lease. The unguaranteed residual value is the portion of the residual value that is not guaranteed by the lessee or is guaranteed solely by a party that is related to the lessor. Often, no part of the residual is guaranteed.

The guaranteed residual value is used in lease arrangements for good reason: it protects the lessor against any loss in estimated residual value, and so ensures that the lessor will get its desired rate of return on its investment.

If the residual value is guaranteed by the lessee, there are both economic and accounting consequences. The accounting difference is that the lease payments that are capitalized as the leased asset are defined to include the guaranteed residual value. Unguaranteed residual values are excluded from the lease payments (or the ASPE “minimum lease payments”). If the residual value is not guaranteed by the lessee, the lessee has no responsibility or obligation for the asset’s condition at the end of the lease. The unguaranteed residual value, therefore, is not included in the calculation of the lease obligation by the lessee.

Difficulty: Easy

Section Reference: IFRS and ASPE Approach – Lessees

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-Use Asset and Capital Leases

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 20-102 Capital lease amortization and journal entries

Erica Corp., who reports under ASPE, leases machinery on January 1, 2023, and records this as a capital lease. Seven annual lease payments of $140,000 are required the end of each year, starting December 31, 2023. The present value of the lease payments at 10% is $681,600. Title passes to Erica at the end of the lease.

Erica uses the effective interest method of amortization for the lease. The company uses straight-line depreciation over the equipment’s expected useful life of eight years, with no residual value.

Instructions (Round values to the nearest dollar.)

a) Prepare a lease amortization table for 2023 and 2024.

b) Prepare the general journal entries relating to this lease for 2023.

c) CRITICAL THINKING: Explain how Erica would determine how to account for this lease. Would this change if the company was using IFRS as opposed to ASPE? If so, explain how.

Solution 20-102

a) 10% Reduction Lease

Date Payments Interest_ Obligation Obligation

Jan 1/23 $681,600

Dec 31/23 $140,000 $68,160 $71,840 609,760

Dec 31/24 140,000 60,976 79,024 530,736

Jan 1, 2023

Equipment under Lease 681,600

Obligations under Lease 681,600

Dec 31, 2023

Interest Expense 68,160

Obligations under Lease 71,840

Cash 140,000

Depreciation Expense ($681,600 / 8) 85,200

Accumulated Depreciation—Machinery 85,200

c) CRITICAL THINKING: When the capital lease method is used, the lessee treats the lease transactions as if the asset were being purchased. The asset and obligation are recorded at the lower of (1) the present value of the minimum lease payments (excluding executory costs) or (2) the fair value of the asset at the inception of the lease.

Under ASPE, the present value of the lease payments is calculated using the lessee's incremental borrowing rate, unless the implicit rate used by the lessor is lower and the lessee has knowledge of it.

Under IFRS, the present value is calculated using the interest rate implicit in the lease whenever this is reasonably determinable, otherwise by using the lessee’s incremental borrowing rate.

The effective interest method is used to allocate each lease payment between interest expense and a reduction of the lease obligation.

If the lease transfers ownership or contains a bargain purchase option, the asset is depreciated in a manner consistent with the lessee's normal depreciation policy over the economic life of the asset and allowing for residual value. If the lease does not transfer ownership, the leased asset is depreciated over the lease term.

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-103 Initial measurement of right-of-use asset and lease liability

Larry Co. leases a fleet of vehicles to Curly Co. for 5 years. The annual lease payment, due at the beginning of the year is $75,000 and the rate implicit in the lease is 8%. Curly Co. records leases under IFRS 16.

Instructions

a) What is the initial journal entry to set up the lease on Curly Co.’s books?

b) CRITICAL THINKING: What does Larry need to take into consideration when it is determining the lease liability?

Solution 20-103

a) Present value of the amount payable under the lease contract i=8%;

$75,000 annuity due x 4.31213 (n=5) =$323,409.75

Journal entry to set up lease:

Right-of-Use Asset 323,410

Lease Liability 248,410

Cash 75,000

b) CRITICAL THINKING: IFRS 16 uses the contract-based approach, the assets and liabilities arise and are recognized at the start of the lease contract. IFRS 16 calls these right-of-use assets.

The liability recognized at the start of the lease is measured at the present value of the lease payments. The amount to be discounted depends on a number of decisions and factors:

1. Do contingent rentals have to be considered?

2. How are any guarantees of residual values at the end of the lease factored into the calculations?

3. Lease contracts often contain renewal or purchase options, sometimes at bargain prices and other times at market rates, or options to end the lease early. Are these considered?

4. What discount rate is used?

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex 20-104 Differences between capital and operating leases under ASPE

a) What are the differences between capital and operating leases under ASPE?

b) What argument do managers present to support an operating versus a capital lease?

Solution 20-104

a) In theory, the total charges to operations are the same over the lease term whether a lease is accounted for as a capital lease or as an operating lease, but the timing of recognition is different. A capital lease has higher charges in the earlier years and lower charges in later years, versus an even and consistent charge under operating leases.

The most important and significant difference; however, is the effect on the balance sheet. A capital lease reports an asset and a liability related to the lease; whereas, an operating lease does not. Capitalizing leases results in higher debt to equity ratios, reduced total asset turnover, and a reduced rate of return on total assets.

b) When arguing against capitalization, managers often state that capitalization can:

More easily lead to violation of loan covenants
Affect the amount of compensation that is received (for example, a stock compensation plan is tied to earnings); and
Lower rates of return and increase debt to equity relationships, thus making the company less attractive to present and potential investors.

Difficulty: Easy

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

Ex. 20-105 Operating lease calculations

On January 1, 2023, Lewis Corp. purchased a building for $900,000, with the intention of leasing it. The building is expected to have a 20-year life, no residual value, and will be depreciated on a straight-line basis. On April 1, 2023, under a cancellable lease, Lewis leased the building to Clark Company for $300,000 a year ($25,000 a month) for a four-year period ending March 31, 2027. Clark paid $300,000 to Lewis on April 1, 2023. During calendar 2023, Lewis incurred $30,000 in maintenance and other executory costs under the provisions of the lease. This lease is properly classified as an operating lease by both parties.

Instructions

a) How much income before income taxes will Lewis report from this lease for calendar 2023?

b) How much rent expense will Clark report in connection with this lease for calendar 2023?

c) What disclosures are required under IFRS 16 for leases that are exempt from right-of-use lease accounting?

Solution 20-105

a) Revenue Apr 1–Dec 31, 2023 ($25,000 × 9) $225,000

Expenses:

Depreciation ($900,000 ÷ 20) × 9 ÷ 12) $33,750

Maintenance, etc. 30,000 63,750

Income before taxes $161,250

b) Rent expense, Apr 1–Dec 31, 2023 ($25,000 × 9) $225,000

c) For those following IFRS 16, companies are required to disclose the expense relating to short term lease exemptions, the expense relating to low-value lease exemptions, and the amount of lease commitments for short-term leases if the short-term leases committed to are dissimilar from the portfolio to which short-term lease expense relates.

Difficulty: Medium

Section Reference: Accounting for an Operating Lease

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-106 IFRS additional disclosures

A right-of-use or capital lease has similar disclosures as in the standards for long-term liabilities and some additional disclosures. What are the additional disclosures?

Solution 20-106

IFRS requires additional disclosures related to:

1. The carrying amount of right-of-use assets at the end of the reporting period by class or underlying asset.

2. A maturity analysis of lease liabilities, separately from the maturity analyses of other financial liabilities.

3. Additional qualitative and quantitative information about leasing activities to help users assess the nature of the company’s leasing activities, future cash outflows, restrictions or covenants imposed by leases and sale and leaseback transactions.

Difficulty: Easy

Learning Objective: Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required.

Section Reference: Presentation and Disclosure

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

Ex. 20-107 Risks and benefits of ownership

Under ASPE, a lease is classified as a capital lease if it substantially transfers the risks and rewards of ownership from the lessor to the lessee and classified as an operating lease if the risks and rewards are not substantially transferred. Given this, explain the risks and rewards of ownership.

Solution 20-107

Rewards of ownership are the ability to use the asset to generate profits over its useful life, benefit from any appreciation in the asset’s value, and realize its residual value at the end of its economic life. The risks, on the other hand, are the exposure to uncertain returns, loss from use or idle capacity, and technological obsolescence.

Difficulty: Easy

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Communication

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Communication

Ex. 20-108 Recording a Manufacturer/Dealer lease by the lessor

On January 1, Lexy Corp. leases a truck it has manufactured to Roxy Corp. Lexy has calculated the lease payments to Roxy to be $40,000 per year for 4 years and the sales price of the truck is $130,000. It cost Lexy $100,000 to manufacture the truck.

Instructions

a) Record the journal entries to set up the lease on January 1 on Lexy’s books.

b) Explain the procedures Lexi would use to account for a sales-type lease (ASPE) or manufacturer or dealer lease (IFRS). How does this differ from the procedures used to account for a direct financing lease (ASPE) or finance lease (IFRS) by the lessor?

Solution 20-108

a) Lexy Corp. is the lessor.

January 1

Lease Receivable (40,000 x 4) 160,000

Unearned Interest Income 30,000

Sales Revenue 130,000

Cost of Goods Sold 100,000

Truck Inventory 100,000

b) The accounting for a sales-type lease is similar to a financing-type lease with the major difference being that the lessor typically has manufactured or acquired the asset in order to sell it and is looking to make a profit on the sale as well as earn interest. So, the cost or carrying value of the amount on the lessor’s books is usually less than the asset’s fair value to the customer, so the lessor will also record a sale and related cost of goods sold in addition to the lease accounting entries.

The lessor records the gross amounts of the minimum lease payments (excluding executory costs) and the unguaranteed residual value (a guaranteed residual value is included in the minimum lease payments) as Lease Receivable. The difference between the gross investment in lease (Lease Receivable) and the asset's sale price, also called the net investment in lease, is recorded as Unearned Interest Income. This is a contra-account to Lease Receivable. The sales price of the asset is recorded as sales revenue. The lessor also records the cost of goods sold and inventory amount at the asset’s carrying value or cost.

The lessor records payments received as a reduction in the receivable. Unearned income is recognized periodically as interest income, using the effective interest method and the implicit interest rate used to calculate the lease payments.

Difficulty: Medium

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-109 Calculation of lease amounts for lessors for Manufacturer/Dealer leases with unguaranteed residuals

Cow Co. is a farming equipment dealer who reports using IFRS. It plans to lease a piece of farming equipment to Horse Inc. and wants to earn a profit on the equipment as well as earn interest. The details of the lease are as follows:

It will be a 5 year lease and will have annual rental payments due at the beginning of the year.
The rate of return Cow Co. wants to earn on the equipment is 7%.
The estimated residual value (unguaranteed) is $10,000 (the present value of which is $7,130).
The annual lease payments are $55,359 (the present value of which is $242,870); and
The leased equipment has a $200,000 cost to the dealer, Cow Co.

Instructions

Calculate the following for Cow Co:

a) gross investment

b) unearned interest income

c) sales revenue

d) cost of good sold

e) gross profit

Solution 20-109

a) Gross investment [(55,359 x 5) + 10,000] $286,795

b) Unearned interest income [286,795 – (242,870 + 7130)] 36,795

c) Sales revenue 242,870

d) Cost of goods sold (200,000 – 7,130) 192,870

e) Gross profit (242,870 – 192,870) 50,000

Difficulty: Medium

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-110 Calculation of lease amounts for lessors for Manufacturer/Dealer leases with guaranteed residuals

It will be a 5-year lease and will have annual rental payments due at the beginning of the year.
The rate of return Cow Co. wants to earn on the equipment is 7%.
The estimated residual value (guaranteed) is $10,000 (the present value of which is $7,130).
The annual lease payments are $55,359 (the present value of which is $242,870); and
The leased equipment has an $200,000 cost to the dealer, Cow Co.

Instructions

Calculate the following for Cow Co:

a) gross investment

b) unearned interest income

c) sales revenue

d) cost of good sold

e) gross profit

Solution 20-110

a) Gross investment [(55,359 x 5) + 10,000] $286,795

b) Unearned interest income [286,795 – (242,870 + 7130)] 36,795

c) Sales revenue (242,870 + 7,130) 250,000

d) Cost of goods sold 200,000

e) Gross profit (250,000 – 200,000) 50,000

Difficulty: Medium

Learning Objective: Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor.

Section Reference: Accounting for Residual Values and Purchase Options in a Financing or Manufacturer/Dealer or Sales-Type Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-111 Operating lease journal entries for the lessor

On January 1, 2023 Green Company, a lessor, provides an operating lease of a car to Red Inc. The annual lease payments are $6,000 and the car is on Green’s books at a cost of $25,000, the expected useful life of the car is 5 years.

Instructions

a) Record the 2023 journal entries for Green Company.

b) Explain how lessors account for operating leases including the lease payments, depreciation and other direct costs. Identify any necessary disclosure requirements under ASPE and IFRS 16.

Solution 20-111

January 1, 2023

Cash 6,000

Rent Revenue 6,000

December 31, 2023

Depreciation Expense ($25,000 / 5-year useful life) 5,000

Accumulated Depreciation 5,000

b) If a lease is classified as operating by the lessor, the lease payments are recognized as rental income and the asset will stay on the books of the lessor. The rental income is recognized on a straight-line basis over each accounting period unless there is a pattern that is a better reflection of how the asset provides benefits. Depreciation, maintenance and other operating costs are expensed in the period they incur. Initial direct costs are deferred and amortized over the lease terms in proportion to the rental income recognized.

ASPE disclosure requirements for operating leases are limited to the cost and related accumulated depreciation of property that is held for leasing purposes, along with the carrying amount of any impaired lease receivables and related allowance provided for impairment.

IFRS disclosure requirements for operating leases are similar to those of finance leases. Lessors report the future minimum lease payments in total as well as the amounts due within one year, between years two and five, and beyond five years. The contingent rental income for the period and general information about the entity’s leasing arrangements are also reported.

Difficulty: Medium

Learning Objective: Account for and report operating leases by a lessor.

Section Reference: Accounting for an Operating Lease

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Ex. 20-112 Differences between ASPE and IFRS 16

Explain how leases are recognized by the lessees and lessors under both IFRS versus ASPE.

Solution 20-112

Lessees:

ASPE requires leases to be classified as capital when the risks and benefits of ownership are transferred to the lessee. The classification criteria include numerical thresholds that are often used. Whereas, under IFRS the lessee recognizes its contractual right to use the leased asset as a right-of-use asset, and its obligation to make rental payments as a lease liability. There are exemptions to this for short-term leases and low-value assets.

Lessors:

ASPE uses classification criteria including numerical thresholds plus two revenue recognition criteria to qualify as a sale-type lease or a direct financing lease. Whereas for IFRS 16 uses the same criteria as the lessee does and then classifies it as a finance lease or a manufacturer/dealer lease depending on the structure.

Difficulty: Easy

Learning Objective: Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

Section Reference: IFRS/ASPE Comparison

CPA: Financial Reporting

Bloomcode: Comprehension

AACSB: Analytic

*Ex. 20-113 Lessee and lessor accounting (sale-leaseback)

On January 1, 2023, Baritone Inc. sells machinery to Contralto Corp. at its fair value of $1,200,000 and immediately leases it back. The machinery’s original cost was $2,000,000, and its book value at January 1, 2023 was $1,050,000. The lease is for 10 years and the implicit interest rate is 10%. The lease payments of $177,500 start on January 1, 2023. Baritone uses straight-line depreciation and assumes there will be no residual value at the end of the 10 years. Assume this lease will be accounted for as a capital (finance) lease by both parties.

Instructions

a) Prepare all of Baritone's 2023 entries to reflect the above sale and lease transactions.

b) Prepare all of Contralto's 2023 entries to reflect the above sale and lease transactions.

c) CRITICAL THINKING: The Vice President of Sales for Baritone is confused by why the sales and financing departments agreed to this transaction. Explain the rationale for this type of transaciton.

*Solution 20-113

a) BARITONE INC. (Lessee)

Jan 1, 2023

Cash 1,200,000

Accumulated Depreciation—Machinery 950,000

Machinery 2,000,000

Deferred Profit on Sale-Leaseback 150,000

Machinery under Lease 1,200,000

Obligations under Lease 1,200,000

Obligations under Lease 177,500

Cash 177,500

Dec 31, 2023

Depreciation Expense 120,000

Accumulated Depreciation—Leased Machinery 120,000

Deferred Profit on Sale-Leaseback 15,000

Depreciation Expense—Leased Machinery 15,000

Interest Expense [$10% × ($1,200,000 – $177,500)] 102,250

Interest Payable 102,250

b) CONTRALTO CORP. (Lessor)

Jan 1, 2023

Machinery Acquired for Lessee 1,200,000

Cash 1,200,000

Lease Receivable ($177,500 x 10) 1,775,000

Machinery Acquired for Lessee 1,200,000

Unearned Interest Income 575,000

Cash 177,500

Lease Receivable 177,500

Dec 31, 2023

Unearned Interest Income 102,250

Interest Income 102,250

c) CRITICAL THINKING: A company may sell and leaseback an asset for financing purposes. If the asset purchase had been financed and subsequently the interest rates have decreased, a sale-leaseback transaction can allow the seller to refinance the purchase at a lower rate. It can also provide additional working capital if the company has tight liquidity.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*Ex. 20-114 Lessee and lessor accounting (sale-leaseback)

On January 1, 2023, Kirk Corp. sells land to Spock Inc. for $2,000,000, and immediately leases the land back. Both companies follow ASPE. The following information relates to this transaction:

1. The term of the non-cancellable lease is 20 years and the title transfers to Kirk at the end of the lease term.

2. The land has a cost basis of $1,600,000 to Kirk.

3. The lease agreement calls for equal rental payments of $203,704 at the end of each year.

4. The land has a fair value of $2,000,000 on January 1, 2023.

5. The incremental borrowing rate of Kirk Corp. is 10%. Kirk is aware that Spock set the annual rentals to ensure a rate of return of 8%.

6. Kirk pays insurance costs, which total $170,000 in 2023.

7. Collectability of the rentals is reasonably assured, and any non-reimbursable costs under the lease that are likely to be incurred can be reasonably estimated by the lessor.

Instructions

a) Prepare all the 2023 journal entries on the books of Kirk Corp. to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.)

b) Prepare all the 2023 journal entries on the books of Spock Inc. to reflect the above purchase and lease transactions.

c) Assume that Kirk only leases land to Spock and that at the end of the lease the land does not transfer to Spock, what kind of lease would this be and why?

*Solution 20-114

a) KIRK CORP. (Lessee)

Jan 1, 2023

Cash 2,000,000

Land 1,600,000

Deferred Profit on Sale-Leaseback 400,000

Land under Lease 2,000,000

Obligations under Lease 2,000,000

Throughout 2023

Insurance Expense 170,000

Accounts Payable or Cash 170,000

Dec 31, 2023

Deferred Profit on Sale-Leaseback ($400,000 ÷ 20) 20,000

Gain from Sale-Leaseback* 20,000

* a revenue account is used since there is no Depreciation Expense here

Interest Expense 160,000

Obligations under Lease 43,704

Cash 203,704

Partial Lease Amortization Schedule

Annual Interest Reduction of

Date Lease Payment 8% Lease Obligation Balance_

Jan 1, 2023 $2,000,000

Dec 31, 2023 $203,704 $160,000 $43,704 1,956,296

b) SPOCK INC. (Lessor)

Jan 1, 2023

Land…………………………………………………………. 2,000,000

Cash…………………………………………………. 2,000,000

Lease Receivable ($203,704 × 20)………………... 4,074,080

Unearned Interest Income…………………………. 2,074,080

Land………………………………………………… 2,000,000

Dec 31, 2023

Cash 203,704

Lease Receivable 203,704

Unearned Interest Income 160,000

Interest Income 160,000

c) If title does not transfer, the lessor and the lessee will both account for the lease as an operating lease as there is no transfer of ownership to Spock, and Kirk would not recognize any expenses such as depreciation over the life of the lease, so the full value of the land would transfer back to Kirk.

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

PROBLEMS

Pr. 20-115 Lessee accounting—capital lease ASPE

Long Ltd., a private corporation adhering to ASPE, enters into a non-cancellable lease agreement on July 1, 2023, to lease equipment from Fong Ltd. The following data are relevant to the lease agreement:

1. The term of the lease is 4 years, with no renewal option. Payments of $126,807 are due on June 30 of each year, with the first payment due June 30, 2024.

2. The fair value of the equipment on July 1, 2023 is $420,000. The equipment has an economic life of 6 years with no residual value.

3. Long depreciates similar equipment it owns on the double declining-balance basis.

4. Long's incremental borrowing rate is 10%. The lessee is aware that the lessor used an implicit rate of 8% in calculating the lease payments.

5. Present value factor for 4 periods at 8% is 3.31213; at 10%, 3.16986.

Instructions

a) What type of lease is this for Long? What is your rationale?

b) Prepare the journal entries on Long's books that relate to the lease agreement for the following dates. Round all amounts to the nearest dollar. Include a partial amortization schedule.

i) July 1, 2023

ii) December 31, 2023

ii). June 30, 2024

iv) December 31, 2024

Solution 20-115

a) Present value of minimum lease payments:

$126,807 × PV of an ordinary annuity for 4 periods at 8% (use the lessor’s implicit rate, since it is known) $126,807 × 3.31213 = $420,000

Because the present value of the lease payments ($420,000) equals the fair value of the leased property, it is a capital lease.

i) July 1, 2023

Equipment under Lease 420,000

Obligations under Lease 420,000

ii) Dec 31, 2023

Depreciation Expense [($420,000 × 2 ÷ 4) × 6 ÷ 12] 105,000

Accumulated Depreciation—Leased Equipment 105,000

Interest Expense ($33,600 × 6 ÷ 12) 16,800

Interest Payable 16,800

Lease Amortization Schedule

Annual Interest on Reduction of Balance of

Date Lease Payment Unpaid Obligation Lease Obligation Lease Obligation

Jul 1/23 $420,000

Jun 30/24 $126,807 $33,600 $ 93,207 326,793

Jun 30/25 126,807 26,143 100,664 226,129

iii) Jun 30, 2024

Interest Expense 33,600

Obligations under Capital Leases 93,207

Cash 126,807

(Interest payable entry assumed to have been reversed Jan 1/20)

iv) Dec 31, 2024

Depreciation Expense 157,500

Accumulated Depreciation—Leased Equipment 157,500

{($420,000 × 2 ÷ 4) + [($420,000 – $210,000) × 2 ÷ 4] × 6 ÷ 12}

Interest Expense ($26,143 × 6 ÷ 12) 13,072

Interest Payable 13,072

Difficulty: Medium

Section Reference: IFRS and ASPE Approach – Lessees

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 20-116 Lessee accounting—capital lease ASPE

On January 1, 2023, Fargo Corp. enters into a ten-year non-cancellable lease with Wells Ltd. for equipment having an estimated useful life of 11 years and a fair value of $6,000,000. Fargo's incremental borrowing rate is 8%, but they do not know Wells’ implicit rate. Fargo uses the straight-line method to depreciate assets. The lease contains the following provisions:

1. Semi-annual lease payments of $438,000 (including $38,000 for property taxes), payable on January 1 and July 1 of each year.

2. A guarantee by Fargo Corp. that Wells Ltd. will realize $200,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $120,000.

Both companies adhere to ASPE.

Instructions

a) Calculate the undiscounted minimum lease payments over the life of the lease.

b) Calculate the present value of the minimum lease payments. PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for $1 due in 20 interest periods at 8% annual rate, .45639. Round to nearest dollar.

c) What kind of lease is this to Fargo Corp.? Why?

d) Present the journal entries that Fargo would record during the first year of the lease. Include an amortization schedule through January 1, 2024 and round values to the nearest dollar.

Solution 20-116

a) The undiscounted minimum lease payments are:

Semi-annual rental payments $ 438,000

Less executory costs (38,000)

400,000

Number of payments over lease term 20

8,000,000

Residual guarantee 200,000

Minimum lease payments $8,200,000

b) The present value of the minimum lease payments is:

Factor for present value of an annuity due, 20 periods, 4% 14.13394

Semi-annual payments, less executory costs $ 400,000

(OR 20 N 4 i 400000 PMT CPT PV => 5,653,576) $5,653,576

Factor for present value of $1 due in 20 semi-annual interest

periods at 4% . 0.45639

Guaranteed residual $200,000 91,278

(OR 20 N 4 i 200000 FV CPT PV => 91,277)

Present value of lease payments $5,744,854

c) This lease is a capital lease to Fargo Corp. because its 10-year term exceeds 75% of the equipment's estimated useful life. In addition, the present value of the minimum lease payments exceeds 90% of the current fair value of the equipment ($6,000,000).

Lease Amortization Schedule

Semi-Annual Interest Reduction of

Date Lease Payment 4%__ Lease Obligation Balance

Initial PV $5,744,854

Jan 1/23 $400,000 — $400,000 5,344,854

Jul 1/23 400,000 $213,794 186,206 5,158,648

Jan 1/24 400,000 206,346 193,654 4,964,994

Jan 1, 2023

Equipment under Lease 5,744,854

Obligations under Lease 5,744,854

AND

Obligations under Lease 400,000

Property Tax Expense 38,000

Cash 438,000

(These two entries can be combined)

Jul 1, 2023

Obligations under Lease… 186,206

Property Tax Expense 38,000

Interest Expense 213,794

Cash 438,000

Dec 31, 2023

Depreciation Expense 554,485*

Accumulated Depreciation—Leased Equipment 554,485

Interest Expense 206,346

Obligations under Lease 206,346

*($5,744,854 – 200,000) ÷ 10 = $554,485

Difficulty: Medium

Learning Objective: Account for right-of-use assets by lessees under IFRS and capital leases under ASPE.

Section Reference: Accounting for a Right-of-use Asset and Capital Leases

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 20-117 Lessee accounting – IFRS

On January 1, 2023, Shrek Inc. enters into a seven-year non-cancellable lease with Fiona Ltd. for machinery having an estimated useful life of nine years and a fair value of $4,300,000. Shrek’s incremental borrowing rate is 8% and Fiona’s implicit rate is 6%. Shrek uses the straight-line depreciation method to depreciate assets. Shrek will make annual lease payments on January 1 of each year. The lease includes a guarantee by Shrek Inc. that Fiona Ltd. will realize $100,000 from selling the asset at the expiration of the lease, which Shrek expects to pay. Both companies adhere to IFRS.

Instructions

a) Calculate the lease payment Fiona Ltd. will charge Shrek (assuming no mark-up of the machinery from fair value). Round to the nearest dollar.

b) Calculate the present value of the lease payments. Round to the nearest dollar.

c) What kind of lease is this to Shrek Inc.? Why?

d) Present the journal entries that Shrek Inc. would record during the first year of the lease. Round to the nearest dollar.

Solution 20-117

a) Investment to be recovered $4,300,000

Less: amount to be recovered through residual amount

PV of residual value ($100,000 x 0.66506) 66,506

(i=6, n=7 using Table A-2)

Amount to be recovered 4,233,494

7 periodic lease payments (4,233,494 / 5.91732) $715,441

(i=6, n=7 using Table A-5)

b) The present value of the lease payments is:

PV of annuity due, 7 periods, 6% is (715,441 x 5.91732) $4,233,494

PV of the guaranteed residual, 7 periods, 6% (100,000x 0.66506) 66,506

Present value of the lease payments $4,300,000

Note: Under IFRS as both the lessor and lessee are using the same implicit rate, the PV of the lease payments equals the fair value of the asset.

c) This is a right-of-use lease and should be capitalized. It does not fall under either exclusion under IFRS of a short-term lease or low-value lease. The lease is a contract that conveys the right to control the use of the identifiable asset for a period of time in exchange for consideration.

Jan 1, 2023

Right-of-Use Asset 4,300,000

Lease Liability 3,584,559

Cash 715,441

Dec 31, 2023

Depreciation Expense (4,300,000 / 7years) 614,286

Accumulated Depreciation—Right-of-Use Asset 614,286

Interest Expense ((4,300,000 – 715,441) x 6%) 215,074

Lease Liability 215,074

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 20-118 Lease accounting – IFRS

On January 1, 2023, Brady Inc. enters into a 5-year non-cancellable lease with Brees Ltd. for equipment that has an estimated useful life of 5 years and a fair value of $2,000,000. Brady’s incremental borrowing rate is 8% and Brees’ implicit rate is 6%. Brady uses the straight-line depreciation method to depreciate assets. Brady will make annual lease payments on January 1 of each year (with the first payment due at the beginning of the lease) based on the fair value of the equipment. The lease agreement includes a guarantee that Brady will take over ownership of the equipment from Brees for a final payment of $100,000. In addition to the equipment, Brees convinced Brady to also lease some small office equipment. For a $300 a month lease payment, for a term of 1 year, Brady gets the equipment it needs to run a small office with 3 staff. Both companies adhere to IFRS.

Instructions

a) Calculate the lease payment Brees Ltd. will charge Brady Inc. assuming that there is no mark up on the fair value of the equipment. Round to the nearest dollar.

b) Calculate the present value of the minimum lease payments. Round to the nearest dollar.

c) Present the journal entries that Brady Inc. would record during the first year of the equipment lease. Round to the nearest dollar.

d) Prepare the journal entries that Brady Inc. would record in the first two months of the office equipment lease. Round to the nearest dollar.

e) CRITICAL THINKING: Are these two lease agreements accounted for differently. If so, why is there a difference?

Solution 20-118

a) Investment to be recovered $2,000,000

Less: amount to be recovered through guaranteed residual amount

PV of residual value ($100,000 x 0.7473) 74,730

(i=6, n=5 using Table A-2)

Recoverable amount $1,925,270

5 periodic lease payments (1,925,270 / 4.4651) $431,182

(i=6, n=5 using Table A-5)

b) The present value of the lease payments is:

PV of annuity due, 5 periods, 6% is (431,182 x 4.4651) $1,925,270

PV of the guaranteed residual, 5 periods, 6% (100,000x 0.7473) 74,730

Present value of the lease payments $2,000,000

Note: Under IFRS as both the lessor and lessee are using the same implicit rate, the PV of the lease payments equals the fair value of the asset.

Jan 1, 2023

Right-of-Use Asset 2,000,000

Lease Liability 1,568,818

Cash 431,182

Dec 31, 2023

Depreciation Expense ($2,000,000 / 5years) 400,000

Accumulated Depreciation—Right-of-Use Asset 400,000

Interest Expense (($2,000,000 – 431,182) x 6%) 94,129

Lease Liability 94,129

d) The lease payment under this agreement would be expensed.

Month 1

Low-Value Lease Expense 300

Cash 300

Month 2

Low-Value Lease Expense 300

Cash 300

e) Under IFRS, this office equipment lease agreement would qualify as a small amount as its 12 months or less and is of low value. Any agreement that does not fall within these characteristics would not meet the exemption and would be automatically capitalized.
One reason that this difference exists is the cost/benefit trade off with respect to relevance and decision usefulness of information. Leases that are small amounts, and for a short term would likely not affect a user’s final decision about the organization. However, there would still be disclosures in the notes about these leases should the user want this type of additional detail.

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 20-119 Lease accounting—Lessee and Lessor—IFRS

On January 1, 2023, Fields Inc. enters into a 5-year non-cancellable lease with Wilson Ltd. for equipment that has an estimated useful life of 5 years and a fair value of $2,000,000. Fields has an incremental borrowing rate of 8% and Wilson’s implicit rate is 6%. Fields uses the straight-line depreciation method to depreciate assets. Fields will make annual lease payments on January 1 of each year (with the first payment due at the beginning of the lease) based on the fair value of the equipment. The lease agreement includes a guarantee that Fields will take over ownership of the equipment from Wilson for a final payment of $100,000. Both companies adhere to IFRS.

Instructions

a) Calculate the lease payment Wilson Ltd. will charge Fields Inc assuming that there is no mark up on the fair value of the equipment. Round to the nearest dollar.

b) Calculate the present value of the minimum lease payments. Round to the nearest dollar.

c) Present the journal entries that Fields Inc. would record during the first year of the equipment lease. Round to the nearest dollar.

d) Prepare the journal entries that Wilson Ltd. would record in the first year assuming that this is a finance lease. Round to the nearest dollar.

Solution 20-119

a) Investment to be recovered $2,000,000

Less: amount to be recovered through guaranteed residual amount

PV of residual value ($100,000 x 0.7473) 74,730

(i=6, n=5 using Table A-2)

Recoverable amount $1,925,270

5 periodic lease payments (1,925,270/4.4651) $431,182

(i=6, n=5 using Table A-5)

b) The present value of the lease payments is:

PV of annuity due, 5 periods, 6% is ($431,182 x 4.4651) $1,925,270

PV of the guaranteed residual, 5 periods, 6% (100,000x 0.7473) 74,730

Present value of the lease payments $2,000,000

Note: Under IFRS as both the lessor and lessee are using the same implicit rate, the PV of the lease payments equals the fair value of the asset.

Jan 1, 2023

Right-of-use Asset 2,000,000

Lease Liability 1,568,818

Cash 431,182

Dec 31, 2023

Depreciation Expense ($2,000,000 / 5years) 400,000

Accumulated Depreciation—Right-of-Use Asset 400,000

Interest Expense (($2,000,000 – 431,182) x 6%) 94,129

Lease Liability 94,129

Jan 1, 2023

Lease Receivable [($431,182 x 5) + 100,000] 2,255,910

Equipment Acquired for Lessee 2,000,000

Unearned Interest Income 255,910

Cash 431,182

Lease Receivable 431,182

Dec 31, 2023

Unearned Interest Income 120,000*

Interest Income 120,000

*FV of equip $2,000,000 x 6% = $120,000

Difficulty: Medium

Learning Objective: Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE).

Section Reference: Accounting for Residual Values and Purchase Options in a Leased Asset

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

Pr. 20-120 Manufacturer/Dealer or sales-type lease versus financing-type lease

How do you distinguish between a manufacturer/dealer or sales-type lease and a financing-type lease?

Solution 20-120

Distinguishing between a manufacturer/dealer or sales-type lease and a financing-type lease depends on the specific situation. Some manufacturers enter into lease agreements either directly or through a subsidiary captive leasing company to facilitate the sale of their product. These transactions are usually manufacturer/dealer or sales-type lease arrangements. Other companies are in business to provide financing to the lessee to acquire a variety of assets in order to generate financing income. They usually enter into direct financing (ASPE) or finance leases (IFRS).

The difference between these classifications is the presence or absence of a manufacturer’s or dealer’s profit (or loss). A sales-type lease (a manufacturer or dealer lease) includes in the rental amount the recovery of a manufacturer’s or dealer’s profit as well as the asset’s cost. The profit (or loss) to the lessor is the difference between the fair value of the leased property at the beginning of the lease, and the lessor’s cost or carrying amount (book value). Manufacturer/dealer or sales-type leases normally arise when manufacturers or dealers use leasing as a way of marketing their products.

Direct financing leases (or finance leases), on the other hand, generally result from arrangements with lessors that are engaged mostly in financing operations, such as lease- finance companies and a variety of financial intermediaries, such as banks or their finance subsidiaries. These lessors acquire the specific assets that lessees have asked them to acquire. Their business model is to earn interest income on the financing arrangement with the lessee.

Difficulty: Easy

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

AACSB: Communication

Pr. 20-121 Lessor accounting—lease with IFRS criteria

On January 1, 2023, Regal Air Inc. enters into an eight-year, non-cancellable lease agreement to lease an aircraft to Atlantic Airlines, with payments required at the end of each year. The following information relates to this agreement:

1. Atlantic Airlines has the option to purchase the aircraft for $7,000,000 at the end of the lease, at which time the aircraft’s fair value is expected to be $12,000,000.

2. The aircraft cost Regal Air $30,000,000. It has an estimated useful life of fifteen years, and a residual value of zero at the end of that time (due to technological obsolescence).

3. Atlantic will pay all executory costs related to the leased airplane.

4. Annual year-end lease payments of $4,562,337 will allow Regal Air to earn an 8% return on its investment.

Instructions

a) What type of lease is this for the lessor? Justify your answer. Assume Regal Air adheres to IFRS.

b) Prepare a lease amortization schedule for Regal Air for the first two years (2023 and 2024). Round all amounts to the nearest dollar.

c) Prepare the journal entries on Regal Air’s books to record the lease agreement, to reflect payments received under the lease, and to recognize income, for the years 2023 and 2024.

Solution 20-121

a) As this is not a short-term lease or a low-value lease, this would be a right-of-use lease under IFRS. The lease is a contract that conveys the right to control the use of the identifiable asset for a period of time in exchange for consideration.

b) Regal Air's Lease Amortization Schedule

Annual Interest on Net Investment

Date Lease Rental Net Investment Recovery Net Investment

Jan 1/23 $30,000,000

Dec 31/23 $4,562,337 $2,400,000 $2,162,337 27,837,663

Dec 31/24 4,562,337 2,227,013 2,335,324 25,502,339

Jan 1, 2023

Lease Receivable [($4,562,337 × 8) + $7,000,000] 43,498,696

Aircraft 30,000,000

Unearned Interest Income 13,498,696

Dec 31, 2023

Cash 4,562,337

Lease Receivable 4,562,337

Unearned Interest Income 2,400,000

Interest Income 2,400,000

Dec 31, 2024

Cash 4,562,337

Lease Receivable 4,562,337

Unearned Interest Income 2,227,013

Interest Income 2,227,013

Difficulty: Medium

Learning Objective: Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

Section Reference: IFRS and ASPE Approach – Lessors

Learning Objective: Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor.

Section Reference: Accounting for Financing and Manufacturer/Dealer or Sales-Type Leases

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

*Pr. 20-122 Sale and Leaseback

Simian Valley Corp. owns both the land and building that it uses for a banana plantation. The original cost of the building was $412,500 and had a book value of $225,000 at January 1, 2023. On this date the building was sold to Bonobo Leasing Inc. for $250,000 and simultaneously leased back to Simian Valley.

The lease had a guaranteed 10-year term and required annual payments of $47,250 on December 31 each year. The lease allows the property to revert to the lessee at the end of the lease. Simian Valley’s incremental borrowing rate is 12%, but they do not know Bonobo’s implicit rate. Bonobo will pay property taxes on the building of $6,000 per year; however, this cost is included in the lease payment. Simian Valley will pay maintenance and other operating costs. The building will be depreciated straight line over its remaining 10-year life. The lease qualifies as a capital (finance) lease since the lease term is equal to the economic life of the building. Simian Valley Corp. follows ASPE.

Instructions

a) Prepare entries on Simian Valley’s books to record the sale and leaseback of the building.

b) Prepare year-end adjusting entries for Simian Valley for 2023.

*Solution 20-122

Cash 250,000

Accumulated Depreciation, Building 187,500*

Building 412,500

Deferred Profit on Sale-Leaseback 25,000

*($412,500 – $225,000)

Building under Lease 250,000

Obligations under Lease 250,000

Interest Expense ($250,000 x 12%) 30,000

Obligations under Lease 30,000

Obligations under Lease 41,250

Property Tax Expense 6,000

Cash 47,250

Depreciation Expense ($250,000 ÷ 10) 25,000

Accumulated Amortization—Leased Building 25,000

Deferred Profit on Sale-Leaseback ($25,000 ÷ 10) 2,500

Depreciation Expense 2,500

Difficulty: Medium

Learning Objective: Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

Section Reference: Other Lease Issues (Appendix 20A)

CPA: Financial Reporting

Bloomcode: Application

AACSB: Analytic

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The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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Created Date:

Aug 21, 2025

Chapter Name:

Chapter 20 Leases

Author:

Donald E. Kieso

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Test Bank Intermediate Accounting v2 13e | Canada

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Chapter 18 Income Taxes

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Chapter 19 Pensions and Other Post-Employment Benefits

DOCX Ch. 19

Chapter 20 Leases

DOCX Ch. 20 Current

Chapter 21 Accounting Changes and Error Analysis

DOCX Ch. 21

Chapter 22 Statement of Cash Flows

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Ch.20 Leases Verified Test Bank 13th Canadian Edition

LEASES

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*Solution 20-113

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