SEATWORK 04 - Leases

Multiple Choice
Identify the choice that best completes the statement or answers the question.

1. The inception of the lease is the

a. Date of the lease agreement.
b. Date of commitment by the parties to the principal provisions of the lease.
c. Earlier of the date of the lease agreement or date of commitment by the parties to the
principal provisions of the lease.
d. Later of the date of the lease agreement or date of| commitment by the parties to the
principal provisions of the lease.
2. It is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the
passage of time, for example, percentage of sales, amount of usage, price index and market rate of interest.
a. Bargain purchase option c. Executory cost
b. Contingent rent d. Variable rent
3. It is that portion of the residual value of the leased asset, the realization of which by the lessor is not assured or is
guaranteed solely by a party related to the lessor.
a. Guaranteed residual value c. Residual value
b. Minimum lease payment d. Unguaranteed residual value
4. Which of the following would be considered an executory cost?
a. Bargain purchase option c. Maintenance cost
b. Interest expense incurred d. Minimum lease payment
5. Which of the following statements is true regarding the lease term?
a. The lease term does not include all periods covered by bargain renewal option.
b. The lease term may extend beyond the date a bargain purchase option becomes
exercisable.
c. The lease term does not include all periods representing renewals or extensions of the
lease at the lessor's option.
d. The lease term includes all periods for which failure to renew imposes a penalty
sufficiently high that the lessee probably will renew.
6. One of the four determinative criteria for a finance lease is that the present value at the beginning of the lease term
of the minimum lease payments equals or exceeds
a. The property's fair market value.
b. 50 percent of the property's fair market value.
c. 75 percent of the property's fair market value.
d. 90 percent of the property's fair market value.
7. If the residual value of a leased asset is greater than the amount guaranteed by the lessee
a. The lessor pays the lessee for the difference.
b. The lessee pays the lessor for the difference.
c. The lessee has no obligation related to the residual value.
d. The lessee recognizes a gain at the end of the lease term.
8. For which of the following transactions would the use of present value of an annuity due concept be appropriate in
calculating the present value of cash flows?
a. A finance lease is entered into with the initial payment due upon signing of the lease.
b. A finance lease is entered into with the initial payment due one month subsequent to the
signing of the lease.
c. A ten-year 8% bond is issued on January 1 with interest payable semiannually on January
1 and July 1 yielding 9%.
 d. A ten-year 8% bond is issued on January 1 with interest payable semiannually on January
1 and July 1 yielding 7%.
9. The cost of an asset under a finance lease is equal to
a. Carrying amount of the asset.
b. Present value of the minimum lease payments.
c. Present value of the minimum lease payments or the fair value of the asset, whichever is
higher.
d. Present value of the minimum lease payments or the fair value of the asset, whichever is
lower.
10. For a finance lease, the amount recorded initially by the lessee as a liability should normally
a. Equal the minimum lease payments
b. Exceed the minimum lease payments
c. Equal the present value of the minimum leasi payments at the beginning of the lease
d. Exceed the present value of the minimum lease payments at the beginning of the lease

The next item(s) is/are based on the following

Real Inc. leases equipment to its customers under noncancelable leases. On January 1, 2006, Real leased
equipment costing P4,000,000 to Quezon Co., for nine years. The rental cost was P440,000 payable in advance
semiannually (January 1 and July 1), plus P20,000 semiannually for executory costs. The equipment had an
estimated life of 15 years and sold for P5,330,250 with an estimated unguaranteed residual value of P800,000. The
implicit interest rate is 12 percent.

11. How much is the total interest income from lease that will be earned by Real, Inc.?
a. P2,869,988 c. P3,675,616
b. P3,389,748 d. P 0
12. Real, Inc. should report profit on the sale at
a. P1,330,252 c. P1,050,012
b. P1,044,384 d. P1,338,492
13. How much should be reported by Quezon Co. as liability under finance lease as of December 31, 2006?
a. P4,143,593 c. P4,273,410
b. P4,446,613 d. P 0
14. How much should be reported by Quezon Co. under current liabilities as liability under finance lease as of
December 31, 2006?
a. P356,798 c. P394,252
b. P378,207 d. P 0
15. How much interest expense should be reported by Quezon Co. in relation to the lease for the year ended December
31, 2006?
a. P508,064 c. P543,398
b. P501,793 d. P 0
16. On December 31, 2014, Tiger Company leased equipment from another entity. Pertinent lease transaction data are
as follows:
* The estimated seven-year useful equipment life coincides with the lease term.
* The first of the seven equal annual P800,000 lease payments was paid on December 31, 2014.
* The implicit interest rate is 12%.
* Tiger's incremental borrowing rate is 14%.
* Present values of an annuity of 1 in advance for seven periods are 5.11 at 12% and 4.89 at 14%.
What amount should be recorded as initial measurement of the equipment?
a. 0 c. 4,088,000
b. 3,912,000 d. 5,600,000
17. On January 1, 2014, Nori Company entered into a 5-year lease for drilling equipment. The entity accounted for the
acquisition as a finance lease for P2,400,000, which included a P100,000 bargain purchase option. At the end of the
lease, the entity is expected to exercise the bargain purchase option. The entity estimated that the equipment's fair
value will be P200,000 at the end of its 8-year life and regularly used straight line depreciation on similar
equipment. What amount should be recognized as depreciation expense on the leased asset for 2014?
a. 275,000 c. 460,000
b. 300,000 d. 480,000
18. On January 1, 2014, Kosovo Company entered into a 10-year lease for an equipment. The entity accounted for the
acquisition as a finance lease for P4,900,000 which includes a P200,000 guaranteed residual value. At the end of
the lease, the asset will revert back to the lessor. It is estimated that the asset's fair value at the end of its 12-year
useful life will be P100,000. The straight line depreciation is used. What amount should be recognized as
depreciation expense on the leased asset?
a. 400,000 c. 480,000
b. 470,000 d. 490,000
19. Camia Company is in the business of leasing new hi-tech equipment. As lessor, Camia Company expects a 12%
return on the net investment. All leases are classified as direct financing lease. At the end of the lease term, the
equipment will revert to Camia Company. On January 1, 2014, an equipment is -leased to another entity with the
following information.
Cost of equipment to Camia Company 5,500,000
Residual value - guaranteed 400,000
Annual rental payable in advance 959,500
Useful life and lease term 8 years
Implicit interest rate 12%
First lease payment January 1, 2014
What amount of interest income should be recognized for 2014?
a. 322,000 c. 544,860
b. 496,860 d. 660,000
20. On December 31,2013, Benz Company, a lessor, sold a machinery that it had been leasing under a direct financing
lease. On January 1,2013 after receipt of the lease payment for the year, the following account balances were
associated with the lease:
Gross lease receivable 5,850,000
Unearned interest income 1,000,000
Present value of lease receivable 4,850,000
The interest rate implicit in the lease is 10%. On December 31, 2013, Benz Company sold the leased machinery to
the lessee for P3,250,000 cash. What is the loss on sale of machinery that should be recognized on December
31,2013?
a. 1,600,000 c. 2,085,000
b. 2,015,000 d. 2,600,000
21. Lyle Company entered into a finance lease on January 1,2013. A third party guaranteed the residual value of the
asset under the lease estimated to be P 120,000 on January 1,2018rthe end of the lease term. Annual lease
payments are PI00,000 due each December 31, beginning December 31, 2013. The last payment is due December
31, 2017. Both the lessor and lessee used 10% as the interest rate. The remaining useful life of the asset was six
years at the commencement of the lease.
The PV of 1 at 10% for 5 periods is .62, and the PV of an ordinary annuity of 1 at 10% for 5 periods is 3.79. What
is the lease receivable of the lessor and lease liability of the lessee at the commencement of the lease?
Lease receivable Lease liability
a. 379,000 379,000 c. 453,400 379,000
b. 379,000 453,400 d. 453,400 453,400

The next item(s) is/are based on the following

 Camia Company is in the business of leasing new sophisticated equipment. As lessor, the entity expects a 12%
return. At the end of the lease term, the equipment will revert to Camia Company. On January 1,2013 an equipment
is leased to another entity under a direct financing lease.
Cost of equipment to Camia 5,500,000
Residual value - unguaranteed 400,000
Annual rental payable in advance 959,500
Useful life and lease term 8 years
Implicit interest rate 12%
First lease payment January 1,2013

22. What is the unearned interest income on January 1,2013?

a. 1,616,500 c. 2,176,000
b. 1,776,000 d. 2,576,000
23. What is the interest income for 2013?
a. 322,000 c. 544,860
b. 496,860 d. 660,000

THE NEXT ITEM(S) IS/ARE BASED ON THE FOLLOWING

Reagan Company used leases as a method of selling products. In 2013, the entity completed construction of a
passenger ferry. On January 1, 2013, the ferry was leased to the Super Ferry Line on a contract specifying that
ownership of the ferry will transfer to the lessee at the end of the lease period. Annual lease payments do not
include executory costs.

Other terms of the agreement are as follows:

Original cost of the ferry 8,000,000
Fair value of ferry at lease date 12,555,000
Lease payments payable in advance 1,500,000
Estimated residual value 2,000,000
Implicit interest rate 12%
Date of first lease payment January 1, 2013
Lease term 20 years
Present value of an annuity due of 1 at 10% for 20 periods 8.37
Present value of 1 at 12% for 20 periods 0.10

24. What is the unearned interest income on January 1, 2013?

a. 17,445,000 c. 19,445,000
b. 19,245,000 d. 22,000,000
25. What is the gross profit on sale for 2013?
a. 4,355,000 c. 4,755,000
b. 4,555,000 d. 6,555,000
26. What is the interest income for 2013?
a. 1,326,600 c. 1,506,600
b. 1,350,600 d. 1,524,600

THE NEXT ITEM(S) IS/ARE BASED ON THE FOLLOWING

Marianas Company adopted the policy of leasing as the primary method of selling its products. The entity's main
product is a small helicopter that is very popular among politicians and entity managers. Marianas Company
constructed such a helicopter for Jade Company at a cost of P8,500,000.
 Financing the construction was at a 14% rate. The terms of the lease provided for annual advance payments of
P2,500,000 to be paid over 10 years with the ownership transferring to the lessee at the end of the lease period. It is
estimated that the helicopter will have a residual value of P1,600,000 at that date.

The lease payments began January 1, 2013. Marianas Company incurred initial direct cost of P500,000 in
financing the lease agreement with Jade. The sale price of the helicopter is P 14,875,000. The present value of an
annuity due of 1 at 14% for 10 periods is 5.95.

27. What is the gross profit on sale that should be recognized by Marianas Company?
a. 4,275,000 c. 5,875,000
b. 4,775,000 d. 6,375,000
28. What is the unearned interest income on January 1, 2013?
a. 8,525,000 c. 10,125,000
b. 9,625,000 d. 11,725,000
29. What is the interest income for 2013?
a. 1,732,500 c. 2,082,500
b. 1,956,500 d. 2,306,500
30. On December 31, 2014, Bain Company sold a machine to Ryan Company and simultaneously leased it back for
one year. Pertinent information at this date follows:
Sale price 360,000
Carrying amount 330,000
Present value of reasonable lease rentals
(P30,000 for 12 months @ 12%) 341,000
Estimated remaining useful life 12 years
In the income statement for 2014, what amount should be reported as gain from the sale of the machine?
a. 0 c. 30,000
b. 4,100 d. 34,100
SEATWORK 04 - Leases
Answer Section

MULTIPLE CHOICE

1. C
2. B
3. D
4. C
5. D
6. D
7. C
8. A
9. D
10. C
11. B
Gross investment in the lease:
Minimum lease payments
(P440,000 x 18) P7,920,00
Unguaranteed residual value 800,000 P8,720,000
Net investment in the lease:
PV of minimum lease payments
(P440,000 x 11.4773) 5,050,012
PV of unguaranteed residual value
(P800,000 x 0.3503) 280,240 5,330,252
Total unearned interest income P3,389,748
12. A
Sales (present value of MLP) P5,050,012
Less cost of sales (P4,000,000 - P280,240) 3,719,760
Profit on sale P1,330,252
13. B
Finance lease liability (P440,000 x 11.4773) P5,050,012
Less lease payment, 1/1/06 440,000
Balance, 1/1/06 4,610,012
Less principal payment on 7/1/06:
Total payment P440,000
Applicable to interest
(P4,610,012 x 12% x 6/12) 276,601 163,399
Balance, 12/31/06 P4,446,613

The lease will be accounted for as finance lease because the present value of the minimum lease payments amount
to substantially all of the fair value of the leased asset at the inception of the lease. (P5,050,012/P5,330,250 =
95%).
14. A
Principal payment due, 1/1/07:
Total payment P440,000
Applicable to interest
(P4,446,613 x 12% x 6/12) 266,797 P173,203
Principal payment due, 7/1/07:
 Total payment P440,000
Applicable to interest
[(P4,446,613 - P173,203) x 12% x 6/12] 256,405 183,595
Current portion of finance lease
liability, 12/31/06 P356,798
15. C
1/1/06 to 6/30/06 (P4,610,012 x 12% x 6/12) P276,601
7/1/06 to 12/31/06 (P4,446,613 x 12% x 6/12) 266,797
Total interest expense P543,398
16. C
(800,000 x 5.11) = 4,088,000
17. A
Cost of leased property 2,400,000
Less: Residual value 200,000
Depreciable amount 2,200,000
Depreciation (2,200,000 / 8) 275,000
18. B
Depreciation for 2014 (4,700,000 / 10 years) 470,000
Cost of leased equipment 4,900,000
Guaranteed residual value (200,000)
Depreciable amount 4,700,000
The guaranteed residual value is deducted from cost in determining depreciable amount because the machine will
revert back to the lessor upon the lease expiration. The lease term of 10 years is used in computing depreciation
because there is no bargain purchase option and no transfer of title. The lease is a finance lease because the lease
term is at least 75% of the life of the asset (10/12 or 83-1/3%)
19. C
Present value of rentals – equal to the cost of the equipment
or net investment 5,500,000
First payment of January 1, 2014 all applicable to principal 959,500
Balance, January 1, 2014 4,540,500
20. C
Interest income for 2013 (10% x 4,850,000) 485,000
Sale price 3,250,000
Carrying amount of lease receivable:
Lease receivable 5,850,000
Unearned interest income (1,000,000-485,000) (515,000) 5,335,000
Loss on sale of machinery (2,085,000)
Entries on December 31, 2013
Unearned interest income 485,000
Interest income 485,000
Cash 3,250,000
Unearned interest income 515,000
Loss on sale of machinery 2,085,000
Lease receivable 5,850,000
21. C
Lessor
Present value of rentals (100,000x3.79) 379,000
Guaranteed residual value (120,000 x .62) 74,400
Lease receivable 453,400
 The lease term is from January 1,2013 to December 31,2017 or 5 years. Thus, the present value factors are
determined for 5 periods.
Lessee
Lease liability (100,000 x 3.79) 379,000
The guaranteed residual value is not included in the lease liability because it is guaranteed by a third party.
22. D
Gross rentals (959,500 x 8) 7,676,000
Residual value 400,000
Gross investment 8,076,000
Net investment - equal to the cost of the equipment 5,500,000
Unearned interest income - January 1, 2013 2,576,000
The difference between gross investment and net investment in the lease is the unearned interest income. The gross
investment is the sum in absolute amount of the gross rentals and residual value, whether guaranteed or
unguaranteed. In a direct financing lease, the net investment is simply the cost of the leased asset plus any initial
direct cost.
Whether guaranteed or unguaranteed, the residual value is included in computation of total financial income if the
leased asset will revert to the lessor at the end of the lease term. Otherwise, the residual value is ignored if title
passes to the lessee at the end of lease term.
23. C
Present value of rentals - equal to the cost of the equipment
or net investment 5,500,000
First payment on January 1,2013 (all principal payment) 959,500
Lease receivable - January 1, 2013 4,540,500
Interest income for 2013 (4,540,500 x 12%) 544,860
24. A
Gross rentals ( 1,500,000 x 20) 30,000,000
Present value or fair value of asset (1,500,000 x 8.37) 12,555,000
Unearned interest income - January 1, 2013 17,445,000
Observe that the present value of rentals is the same as the fair value of the asset.
Note also that the residual value is ignored because the ownership of the asset will transfer to the lessee at the end
of the lease term
25. B
Fair value of asset - sales revenue 12,555,000
Cost of sales 8,000,000
Gross profit on sale 4,555,000
26. A
PV of rentals equal to the fair value of asset 12,555,000
Payment on January 1,2013 - all applicable to principal 1,500,000
Lease receivable - January 1, 2013 11,055,000
Interest income for 2013 (11,055,000 x 12%) 1,326,600
27. C
Sale price 14,875,000
Cost of sales (8,500,000)
Initial direct cost (500,000)
Gross profit on sale 5,875,000
28. C
Gross rentals (2,500,000 x 10) 25,000,000
Present value of rentals - equal to the sales price 14,875,000
Unearned interest income - January 1, 2013 10,125,000
 The residual value is ignored because the ownership of the asset will transfer to the lessee at the end of the lease
term.
29. A
Present value of rentals 14,875,000
Advance rental payment on January 1, 2013 2,500,000
Lease receivable - January 1, 2013 12,375,000
Interest income for 2013 (12,375,000 x 14%) 1,732,500
30. C
Sales price 360,000
Carrying amount 330,000
Gain on sale and leaseback 30,000