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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

What are the major lessor groups in the United States? What advantage does a captive have in a leasing arrangement?

Question: Lessee Entries; Capital Lease with Unguaranteed Residual Value) On January 1, 2017, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of \(8,668 at the beginning of each year, starting January 1, 2017. The machine has an estimated useful life of 6 years and a \)5,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke鈥檚 incremental borrowing rate is 10%, and the lessor鈥檚 implicit rate is unknown.

Instructions

(c) Prepare all necessary journal entries for Burke for this lease through January 1, 2018.

Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

  1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
  2. The cost of the machinery is \(525,000, and the fair value of the asset on January 1, 2017, is \)700,000.
  3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight-line basis.
  4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
  5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen鈥檚 incremental borrowing rate is 11%, and the lessor鈥檚 implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

  1. Discuss the nature of this lease for both the lessee and the lessor.

What disclosures should be made by lessees and lessors related to future lease payments?

Question: (Balance Sheet and Income Statement Disclosure鈥擫essor) Assume the same information as in P21-4.

(Balance Sheet and Income Statement Disclosure鈥擫essee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017

\(300,383

Residual value at end of lease term

鈥�0鈥�

Lessor鈥檚 implicit rate

10%

Lessee鈥檚 incremental borrowing rate

10%

Annual lease payment due at the beginning of each year, beginning with October 1, 2017

\)62,700

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to \(5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This \)5,500 is not included in the rental payment of \(62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.

Date

Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?

Receivable

Balance of Lease Liability/Receivable

10/01/17

\)300,383

10/01/17

\(62,700

\)62,700

237,683

10/01/18

\(62,700

\)23,768

38,932

198,751

10/01/19

\(62,700

19,875

42,825

155,926

10/01/20

\)62,700

15,593

47,107

108,819

10/01/21

\(62,700

10,882

51,818

57,001

10/01/22

\)62,700

5,699*

57,001

0

\(376,200

\)75,817

$300,383

b) Assuming the lessor鈥檚 accounting period ends on December 31, answer the following questions with respect to this lease agreement.

4. What items and amounts will appear on the lessor鈥檚 balance sheet at December 31, 2018?
See all solutions

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