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Chapter 21: Q.21-11STQ (page 1262)

Question: Which of the following is not a criterion for a lease to be recorded as a finance lease?

  1. There is transfer of ownership.
  2. The lease is cancelable.
  3. The lease term is for the major part of the economic life of the asset.
  4. There is a bargain-purchase option.

Short Answer

Expert verified

Answer

The correct option is 2) The lease is cancelable.

Step by step solution

01

Meaning of Lease

A lease is a contract in which the owner of the property grants the user of the property the right to use the property for a set length of time. The owner of the property is referred to as the 'lessor,' while the user to whom the rights are transferred is referred to as the 'lessee.'

02

Explanation for the correct option

A finance lease is a non-cancellable lease since neither the lessee nor the lessor can cancel it before the lease's planned termination date as long as both parties fully comply with the lease's contractual terms and conditions.

Option 2) is clearly the correct answer, as evidenced by the accompanying explanation.

03

Explanation for the incorrect option

Option 1) In a financial lease, the transfer of ownership is possible and it is transferred to the lessee.

Option 3) The lessor transfers the asset to the lessee for a long period of time under a finance lease. In most cases, this time encompasses a significant portion of the asset's economic life.

Option 4) A bargain purchase occurs when a firm buys another company for less than the fair market value of its assets. So, in finance lease bargain purchase is possible.

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Most popular questions from this chapter

The residual value is the estimated fair value of the leased property at the end of the lease term.

(a) Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessee鈥檚 accounting for a capitalized-lease transaction?

(Lessee Entries and Balance Sheet Presentation, Capital Lease) Ludwick Steel Company as lessee signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of \(40,000 are to be made at the beginning of each lease year (December 31). The taxes, insurance, and the maintenance costs are the obligation of the lessee. The interest rate used by the lessor in setting the payment schedule is 9%; Ludwick鈥檚 incremental borrowing rate is 10%. Ludwick is unaware of the rate being used by the lessor. At the end of the lease, Ludwick has the option to buy the equipment for \)1, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Ludwick uses the straight-line method of depreciation on similar owned equipment.

Instructions

(d) What amounts would appear on Ludwick鈥檚 December 31, 2019, balance sheet relative to the lease arrangement?

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(c) Prepare all of the lessor鈥檚 journal entries for the first year.

Walker Company is a manufacturer and lessor of computer equipment. What should be the nature of its lease arrangements with lessees if the company wishes to account for its lease transactions as sales-type leases?

Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston鈥檚 specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

Winston鈥檚 incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is \)2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Instructions

(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.
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