EX3 1. GAAP establishes specific criteria for the treatment of leases. If any of the criteria are met, the lessee: A. must treat the lease as an operating lease. B. must treat the lease as a capital lease. C. may choose the treatment if two or less criteria are met. D. may elect to treat the lease as an operating lease if only one criterion is met. 2. On January 1, 2014, Lessee Corporation entered into a ten-year lease. The lease terms required annual year-end payments of $160,000. The lease agreement does not contain either a bargain purchase option or a transfer of title. The fair value of the equipment at the inception of the lease was $1,100,000; estimated life of the leased assets was fourteen years. Lessee Corporations incremental borrowing rate was 10%; the implicit rate of interest, known to the lessee, was 12%. Applicable time value of money values are as follows: Ten-year, 10% ordinary annuity 6.144 Ten-year, 12 % ordinary annuity 5.650 Ten-year, 10% annuity due 6.759 Ten-year, 12% annuity due 6.328 Lessee Corporation should initially capitalize the lease at what amount? A. $0, the lease should not be capitalized B. $983,040 C. $1,081,440 D. $904,000 3. If a car dealership leases cars for four years with guaranteed purchase options, guaranteed residual values, and insured financing agreements, these leases are treated as _____ leases. A. operating B. capital C. sales-type D. direct-financing 4. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 If the equipment is worth $12,500 at the end of the lease, Pepper will make which one of the following journal entries? A. DR Obligation under capital lease 12,500 CR Leased equipmentCapital lease 12,500 B. DR Obligation under capital lease 10,000 CR Leased equipmentCapital lease 10,000 C. DR Obligation under capital lease 10,000 CR Accumulated depreciation 10,000 D. No entry required 5. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 Upon acquisition, the leased equipment will be valued on Peppers balance sheet at: (Round all calculations to the nearest whole dollar amount.) A. $144,475. B. $157,469. C. $175,000. D. $250,000. 6. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 The Pepper lease is a/an: A. operating lease because the lease value is less than 90% of the fair value of the asset. B. capital lease because the lease value is 90% of the fair value of the asset. C. operating lease because the asset reverts to Blue at the end of the lease. D. capital lease because the lease term is more than 75% of the life of the asset. 7. The difference in the lessors income recognition over the life of the lease, between an operating lease and a capital lease is: A. zero. B. the amount of the interest revenue. C. the financing revenue minus the depreciation. D. the depreciation expense. 8. Compared to a firm with a capital lease, operating leases help the lessee firm earn: A. higher asset turnover ratio. B. lower return on assets. C. higher debt-to-equity ratio. D. lower NOPAT. 9. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 How much straight-line depreciation expense will Pepper record for Year 1? (Round all calculations to the nearest whole dollar amount.) A. $14,747 B. $15,362 C. $15,747 D. $17,500 10. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 If the equipment is worth $7,500 at the end of the lease, Pepper will make which one of the following journal entries? A. DR Obligation under capital lease 7,500 CR Leased equipmentCapital lease 7,500 B. DR Obligation under capital lease 12,500 CR Leased equipmentCapital lease 10,000 CR Cash 2,500 C. DR Obligation under capital lease 10,000 DR Loss on residual value guarantee 2,500 CR Leased equipmentCapital lease 10,000 CR Cash 2,500 D. No entry required 11. The most straightforward method for making lessees balance sheet data comparable is to treat all leases as if they were _____ leases. A. operating B. capital C. direct financing capital D. sales-type capital 12. Under IFRS, which of the following is an indicator of a situation (individually or in combination) that could lead to a lease being classified as a finance lease? A. If the lessor can cancel the lease, the lessees losses associated with the cancellation are borne by the lessor. B. The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent. C. Gains or losses from the fluctuation in the fair value of the residual accrue to the lessor. D. All of the choices are indicators. 13. A lease is legally a/an ___________ contract. A. mutually performed B. executed C. executory D. unilateral 14. Under IFRS: A. disclosure of lessee future minimum lease payments for the periods within one year, within years two through five, and after five years are required. B. lessees can classify some assets held under leases as investment property. C. the two additional lessor criteria provided under U.S. GAAP for lease revenue recognition are absent. D. All of the choices are correct. 15. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 The lease liability will be valued on Peppers balance sheet at: (Round all calculations to the nearest whole dollar amount.) A. $144,475. B. $157,469. C. $175,000. D. $250,000. 16. GAAP defines lessors treatment of leases according to Type I and Type II characteristics. Type I characteristics are linked to: A. the critical event criteria for expense recognition. B. the critical event criteria for revenue recognition. C. measurement of collectibility for revenue recognition. D. measurement of historical cost. 17. To adjust for distortions that arise from off-balance sheet leases when comparing among firms, analysts rely on: A. the balance sheet. B. the income statement. C. the statement of stockholders equity. D. required note disclosures. 18. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 At the end of Year 1, Pepper will make a payment of $30,000. Which one of the following entries will properly record this payment? (Round all calculations to the nearest whole dollar amount.) A. DR Obligation under capital lease 30,000 CR Cash 30,000 B. DR Obligation under capital lease 14,253 DR Interest expense 15,747 CR Cash 30,000 C. DR Obligation under capital lease 9,253 DR Maintenance expense 5,000 DR Interest expense 15,747 CR Cash 30,000 D. DR Obligation under capital lease 25,000 DR Maintenance expense 5,000 CR Cash 30,000 19. Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. Present value interest factors are: 10% 12% PVIF $1 10 periods 0.38554 0.32197 PVIF Annuity 10 periods 6.14457 5.65022 The entry to record this lease on Peppers books is: (Round all calculations to the nearest whole dollar amount.) A. DR Leased equipmentCapital lease 144,475 CR Obligation under capital lease 144,475 B. DR Leased equipmentCapital lease 157,469 CR Obligation under capital lease 157,469 C. DR Leased equipmentCapital lease 157,469 DR Discount on lease obligation 92,531 CR Obligation under capital lease 250,000 D. DR Leased equipmentCapital lease 167,469 DR Discount on lease obligation 82,531 CR Obligation under capital lease 250,000 20. If a lease contains a residual value guarantee, the lessee must: A. add the guaranteed amount to the present value of the minimum lease payments. B. add the present value of the guaranteed amount to the present value of the minimum lease payments. C. include the guaranteed amount in the minimum lease payments only if the lessee intends to keep the asset at the end of the lease. D. ignore the guaranteed amount if the lessee intends to keep the asset at the end of the lease