Finance Lease Classification Quiz

Questions and Answers

Which of the following is not a sufficient criterion for a lessee to classify a lease as a finance lease?

The lease term is greater than two-thirds of the economic life of the asset. (correct)

The lease transfers ownership of the leased asset to the lessee at the end of the lease term.

The lessee has the option of acquiring the asset during or at the end of the lease term at a bargain price.

The present value of the lease payments is substantially all of the fair value of the leased asset.

In an operating lease in which the asset's economic life and lease term are different, what is true?

The lessor amortizes the leased asset over the term of the lease.

The lessee amortizes the leased asset over the term of the lease at a straight-line amount.

The lessee amortizes the leased asset at an amount that increases each period. (correct)

The lessee amortizes the asset over its economic life.

On a five-year lease of equipment with a fair value of $485,100, how much interest revenue will Universal earn over the life of the lease?

96,575

What amount of interest revenue from the lease should Barr report in its 2021 income statement?

The interest is calculated based on the fair value of the asset. Signup and view all the answers

What is the total increase in earnings (pretax) on Grant's 2021 income statement?

94,500 Signup and view all the answers

A lease is classified as a finance lease if the usual risks and rewards are retained by the lessor.

False Signup and view all the answers

Under IFRS, a lessee will reassess variable lease payments that depend on an index or a rate:

Only when the lessee remeasures the right-of-use asset and lease liability for other reasons. Signup and view all the answers

What will be the balance in the right-of-use asset after two years for Geron Co.?

320,000 Signup and view all the answers

What is the balance in the right-of-use asset at December 31, 2021, for Natick Co.?

126,698 Signup and view all the answers

What amount of interest revenue from the lease should King report in its 2021 income statement?

3.4 million Signup and view all the answers

What is the total increase in earnings (pretax) in King's 2021 income statement?

10.4 million Signup and view all the answers

What amount of total decrease in earnings (pretax) in Nichols' 2021 income statement would be recorded?

7,400,000 Signup and view all the answers

What would be the total increase in earnings (pretax) on Crawford's 2021 income statement?

94,500 Signup and view all the answers

Which of the following is required in order for a contract to contain an identified asset?

The property must be property, plant, or equipment (not inventory, intangibles, or natural resources). Signup and view all the answers

Which of the following is not required in order for a contract to contain a lease?

The asset must be explicitly identified in the contract. Signup and view all the answers

A gain resulting from a sale-leaseback transaction should:

Be deferred at the time of the sale-leaseback and subsequently amortized. Signup and view all the answers

Assuming a tax rate of 40%, what should List Corporation report net income of?

54,000 Signup and view all the answers

The most common cause for variation in reported amounts for deferred taxes between U.S. GAAP and IFRS are:

The nontax differences between IFRS and U.S. GAAP. Signup and view all the answers

Study Notes

Lease Classification Criteria

A lease is classified as a finance lease if the usual risks and rewards are transferred to the lessee.
The presence of options to purchase the asset at a bargain price or if the lease term exceeds two-thirds of the asset's economic life aren't sufficient alone for classification as a finance lease.

Operating Lease Amortization

In an operating lease with different economic life and lease term, amortization is typically at an increasing amount each period.

Interest Revenue Calculation

Universal Leasing Corp. expects a total interest revenue of $96,575 over five years from a lease with an annual payment of $116,334.
Barr Machinery must report interest revenue for 2021 as calculated from the present value of asset lease payments after accounting for received payments.

Right-of-Use Asset Balances

In finance leases, the right-of-use asset is amortized on a straight-line basis, resulting in reduced book value over time.
After two years of a ten-year finance lease, a right-of-use asset balance reduced to $320,000 indicates annual amortization of $40,000.

Operating Lease Amortization Considerations

In operating leases, the total balance of a right-of-use asset at year-end reflects interest expense and amortization adjustments, leading to specific year-end balances.

Total Earnings Impact

A lease agreement that transfers control allows for reporting both interest revenue and selling profit as increases in pre-tax earnings.
For Nichols Fruits, the total increase in earnings due to leasing arrangements totaled $10.4 million, combining selling profit and interest revenue.

Sale-Leaseback Transactions

Gains from sale-leaseback transactions where the seller retains usage rights are amortized over the lease term and deferred initially.

Deferred Taxes Reporting

Differences between reported accounting income and taxable income arise from temporary differences, impacting reported net income.
The most common cause for variations in reported deferred tax amounts between U.S. GAAP and IFRS stems from non-tax differences.

Identified Asset Criteria

For a lease to exist, the asset must be property, plant, or equipment, and cannot include substitutes during the lease period as identified benefits.
Not all contract assets need to be explicitly specified to qualify as a lease; customer benefits and control during the contract term are more critical factors.

Tax Reporting

Taxable income adjustments due to temporary differences should reflect correctly on financial statements, yielding a net income of $54,000 at a 40% tax rate from a pretax income of $90,000.

These notes encapsulate key principles and calculations related to leases, tax impacts, and financial reporting in clarity and brevity, essential for effective study sessions.

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Description

Test your knowledge on finance lease classifications with this quiz. Identify the criteria that do not qualify a lease as a finance lease based on ownership transfer, lease term, and payment present value. Perfect for accounting students!