LEASES – Quiz Material

1. If the lessor records the unearned rent at the inception of a lease, then the lease must:
(a) be an operating lease
(b) be a direct financing lease
(c) contains a bargain purchase option
(d) be an annuity due A

2. Generally accepted accounting principles require that certain lease agreements be accounted
for as purchases. The theoretical basis for this treatment is that a lease:
(a) provides the use of the leased asset to the lessee for a limited period of time
(b) effectively conveys all of the benefits and risks incident to the ownership of property
(c) is an example of form over substance
(d) must be recorded in accordance with the concept of cause and effect B

3. The classification of leases, from the standpoint of the lessee, are:

(a) finance, directing financing, or sales type
(b) direct financing, or sales type
(c) direct financing, sales type, or operating
(d) finance or operating D

4. When a nonrefundable down payment on a leased asset is made in advance under an

operating lease, at the payment date, the lessor credits:
(a) lease liability
(b) unearned rent
(c) cash
(d) rent revenue B

5. The basic accounting issue for lessors is:

(a) computing depreciation on the leased asset
(b) revenue recognition during the lease term
(c) determination of the cost of the leased asset
(d) expense recognition during the lease term B

6. Which of the following is the complete list of classifications of leases from the standpoint of
the lessor?
(a) direct financing, sales type, and operating
(b) direct financing, sales type, and leveraged
(c) direct financing, and sales type
(d) direct financing, sales type, leveraged, and operating D

7. The term usually used to describe the situation where a lessee has an option to purchase the
leased property at a price that is sufficiently lower than its fair market value so that the
exercise of the option appears reasonably assured is:
(a) assured purchase option
(b) bargain buy-out option
(c) bargain purchase option
(d) bargain renewal option C

8. If the lessor and lessee use different interest rates to account for a finance lease, then:
(a) the lessor will use different account titles to record the leasing transaction
(b) total expenses (or revenues) will be equal for each
(c) total expenses (or revenues) will be different for each
(d) the lessee and lessor cannot use different interest rates C
9. Earth Company made the following journal entry at the end of the first lease year:
Rent expense P1,500
Cash P1,500
Earth Company must have a(n):
(a) direct financing lease
(b) operating lease
(c) finance lease
(d) sales type lease B

10. The straight line method is frequently used to amortize nonrefundable rental payments made
in advance on leased assets because:
(a) GAAP requires that it be used in all situations
(b) the interest method may result in unreliable amounts being recognized as expense
(c) it is more theoretically sound
(d) it is less complex, therefore, less costly D

11. Dip Company received an P8,000 advance, nonrefundable, bonus payment on a 5-year
operating lease. An acceptable accounting treatment for this lease bonus is:
(a) recognize P8,000 revenue at the end of the lease term
(b) recognize P8,000 revenue when the cash is received
(c) recognize P1,600 revenue at the end of the first year of the lease term
(d) to record an P8,000 deferred charge until the other rental payments are assured C

12. Under a finance lease that includes a bargain purchase option, how is depreciation on the
asset under lease recognized by:
Lessor Lessee
(a) not recognized depreciate over lease term
(b) not recognized depreciate over remaining life
(c) depreciate over remaining life depreciate over remaining life
(d) depreciate over remaining life not recognized B

13. The lessee measures the cost of a leased asset, and the corresponding lease liability of a
finance lease, at the:
(a) fair market value of the leased asset
(b) future value of the periodic rental payments
(c) sum of the annual cash payments to be made during the term of the lease
(d) present value of the periodic rental payments D

14. The depreciation period used by the lessee for a depreciable leased asset must be:
(a) the same period that was used by the lessor
(b) the remaining life of the asset from the lease inception
(c) the term of the lease
(d) at least the term of the lease but possibly longer D

15. Among the following types of finance leases, for the lessor, which likely recognizes the
greatest amount of revenue at inception?
(a) sales type
(b) direct financing
(c) operating
(d) among those in this list, there would be no material difference A

16. A lessee enters into a finance lease which has a bargain purchase option. What is the period,
and residual value respectively, to be used for depreciating the leased asset?
Period for depreciation Residual value
(a) lease term residual value at end of total useful life
(b) lease term residual value at the end of lease term
(c) remaining useful life residual value at the end of total at
inception useful life
(d) lease term zero
(e) remaining useful life residual value at end of lease at inception
term C
17. The lessor must classify a sale-and-leaseback arrangement as a(n):
(a) direct financing lease or a sales type lease
(b) direct financing lease or an operating lease
(c) operating lease or a finance lease
(d) operating lease or a sales type lease B

18. In a sale and leaseback arrangement, the lessee is also:

(a) the new owner of the property
(b) the buyer
(c) the seller
(d) a third party guarantor C

19. Executory costs include:

(a) interest expense incurred
(b) annual lease rentals paid
(c) insurance premiums
(d) leasehold improvements C

20. A lessee wants to lease an asset on a long-term noncancelable basis, but wants to avoid
capitalizing the lease. Which of the following strategies has the best chance of achieving the
lessee’s goal?
(a) use a lessee guarantee of residual value
(b) make it impossible for the lessee, who has a very low borrowing rate, to determine the
lessor’s implicit rate, which is much higher than the lessee’s borrowing rate
(c) include a bargain purchase option in the lease agreement
(d) use a third-party guarantee of residual value D

Items 21 to 23:
Elixir Company acquired a second-hand heavy equipment on January 1, 2002 for
P4,600,000 cash for the purpose of leasing it. In addition, Elixir incurred P200,000 for a major
overhaul making the equipment in good operating condition. The heavy equipment is
estimated to have a useful life of 10 years with salvage value of P600,000 from the date of
purchase. Depreciation is computed using the straight-line basis.
On May 1, 2002, Elixir leased the heavy equipment to Excel Company for a four-year
period ending April 30, 2006, at a monthly rental of P75,000. Excel paid P900,000 lease fee
for one year and P288,000 lease bonus to obtain the lease. There is no provision or purchase
of the machine by the lessee upon the expiration of the lease.
During 2002, Elixir spent the amount of P35,000 for minor repairs, P15,000 for
transportation, P50,000 for yearly insurance, and P60,000 for commission associated with
lease negotiation in May 1, 2002.

21. How much was the net income of the lessor for the calendar year 2002?
(a) P740,000 (b) P320,000 (c) P396,667 (d) P134,667 D

22. Who had the right to record the depreciation of the leased heavy equipment?
(a) Elixir Company (c) Both Elixir and Excel
(b) Excel Company (d) None of them A

23. How much was the expenses of the lessee for the calendar year 2002?
(a) P 0 (b) P420,000 (c) P648,000 (d) P552,000 C

Items 24 to 26:
White Company closed a contract to lease equipment to Black Company on January 1,
2002. The lease is appropriately accounted for as a sale by White and as purchase by Black.
The lease is for a 10-year period which approximates the useful life of the asset. The first
of 10 equal annual payments of P500,000 was made on January 1, 2002. Black Company
must also make annual payment of P10,000 for taxes and P30,000 for insurance. The
contract was negotiated to assure the lessor a 12% rate of return.
White purchased the equipment for P2,675,000 and established a list selling price of
P3,375,000 on the equipment. White uses the perpetual inventory system.
The present value of 1 at 12% for nine periods is 0.361 and for ten periods is 0.322. The
present value of an annuity of 1 at 12% for nine periods is 5.328 and for ten periods is 5.650.

24. How much was the net income of the lessor for the calendar year 2002?
(a) P 0 (b) P489,000 (c) P672,810 (d) P808,680 Bonus

25. How much was the lease liability of the lessee as of December 31, 2002?
(a) P3,164,000 (b) P2,483,680 (c) P2,664,000 (d) can’t be determined D
26. What type of lease did the problem illustrate?
(a) operating lease (c) both operating and capital leases
(b) capital lease (d) sale and leaseback D

27. Ace purchased a machine on January 1, 2002 for P1,440,000 for the purpose of leasing it.
The machine is expected to have an 8-year life from date of purchase, no residual value, and
be depreciated on the straight line basis. On February 1, 2002, the machine was leased to
Fox Company for a 3-year period ending January 31, 2005 at a monthly rental of P30,000.
Additionally, Fox paid P72,000 to Ace on February 1, 2002 as a lease bonus. Ace incurred
insurance and related costs of P12,000 under the lease. What is the amount of income
before income taxes that Ace should report on this leased asset for the year ended December
31, 2002?
(a) P172,000 (b) P160,000 (c) P222,000 (d) 175,000 B

28. Heart Company leased a new machine from Ash Company on December 31, 2002 under a
lease with the following pertinent information:
Lease term 8 years
Annual rental payable at beginning of each lease year P500,000
Useful life of the machine 10 years
Present value of the 8 lease payments at 12/31/2002 P2,580,000
Machine reverts to Ash at lease expiration date
The machine has a fair value of P2,800,000 at the inception of the lease. Heart uses the
straight line method of depreciation. For the year ended December 31, 2003, how much
depreciation should Heart record for the capitalized lease machine?
(a) P350,000 (b) P322,500 (c) P280,000 (d) P258,000 B

Items 29 and 30:

On January 1, 2000, Pride Corporation sold an equipment with remaining life of 5 years. At
the same time, Pride leased back the equipment for 5 years. Other data are:
Cost of equipment P3,000,000
Accumulated depreciation 1,400,000
Sales price (present value of rentals, rounded) 1,900,000
Annual rental payable at year-end 500,000
Interest rate implicit in the lease 10%
Present value of an annuity of 1 at 10% for 5
periods 3.791
Assume that the leaseback is a capital lease because Pride can acquire the equipment at a
nominal amount at the end of the lease term.

29. How much is the deferred revenue on sale and leaseback?

(a) P 0 (b) P220,000 (c) P240,000 (d) P300,000 D

30. How much is the depreciation expense?

(a) P 0 (b) P190,000 (c) P260,000 (d) P380,000 D

31. K Inc. leases and operates a retail store. The following information relates to the lease for
the year ended December 31, 2002:
a. The store lease, an operating lease, calls for a base monthly rent of P1,500 on the first
day of each month.
b. Additional rent is computed at 6% of net sales over P300,000 up to P600,000 and 5% of
net sales over P600,000 per calendar year.
c. Net sales for 2002 were P900,000.
d. K paid executory costs to the lessor for property taxes of P12,000 and insurance of
P5,000.
For 2002, K Inc. expenses relating to the store lease are:
(a) P71,000 (b) P68,000 (c) P54,000 (d) P35,000 B

32. As an inducement to enter a lease, Arts, Inc. a lessor, grants Hompson Corporation, a lessee,
nine months of free rent under a five year operating lease. The lease is effective on July 1,
2002 and provides for monthly rental of P10,000 to begin April 1, 2003.
In Hompson’s income statement for the year ended June 30, 2003, rent expense should
be reported as:
(a) P102,000 (b) P90,000 (c) P30,000 (d) P25,500 A

33. Kay Company, a lessor of office machines, purchased a new machine for P600,000 on January
1, 2002, which was leased the same day to Lee. The machine will be depreciated at P55,000
per year. The lease is for a four-year period expiring January 1, 2006, and provides for
annual rental payments of P100,000 beginning January 1, 2002. Additionally, Lee paid
 P64,000 to Kay as a lease bonus. In its 2002 income statement, what amount of revenue and
expense should Kay report on this leased asset?
Revenue Expense Revenue Expense
(a) P100,000 P0 (c) P116,000 P55,000
(b) P116,000 P0 (d) P164,000 P55,000 C

34. Barnel Corporation owns and manages 19 apartment complexes. On signing a lease, each
tenant must pay the first and last month’s rent and a P5,000 refundable security deposit. The
security deposits are rarely refunded in total, because cleaning costs of P1,500 per apartment
are almost always deducted. About 30% of the time, the tenants are also charged for
damages to the apartment, which typically cost P1,000 to repair. If a one-year lease is
signed on a P9,000 per month apartment, what amount should Barnel report as refundable
security deposit?
(a) P14,000 (b) P5,000 (c) P3,500 (d) P3,200 B

35. On January 1, 2002, Clay Company leased a new machine form Saxe Corporation. The
following data relate to the lease transaction at the inception of the lease:
Lease term 10 years
Annual rental payable at beginning of each lease year P50,000
Useful life of machine 15 years
Implicit interest rate 10%
Present value of an annuity of P1 in advance for 10
periods at 10% 6.76
Present value of an annuity of P1 in arrears for 10
periods at 10% 6.15
Fair value of the machine P400,000
The lease has no renewal option, and the possession of the machine reverts to Saxe when
the lease terminates. At the inception of the lease, Clay should record a lease liability of:
(a) P400,000 (b) P338,000 (c) P307,500 (d) P 0 D

36. On December 31, 2002, Day Company leased a new machine from Parr with the following
pertinent information:
Lease term 6 years
Annual rental payable at beginning of each lease year P50,000
Useful life of the machine 8 years
Day’s increment borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of an annuity of P1 in advance for 6
periods at:
12% 4.61 15% 4.35
The lease is renewable, and the machine reverts to Parr at the termination of the lease. The
cost of the machine on Parr’s accounting records is P375,500. At the inception of the lease,
Day should record a lease liability of:
(a) P375,500 (b) P230,500 (c) P217,500 (d) P 0 B

37. Robin leased a machine from Ready. The lease qualifies as a capital lease and requires 10
annual payments of P10,000 beginning immediately. The lease specifies an interest rate of
12% and a purchase option of P10,000 at the end of the tenth year, even though the
machine’s estimated value on that date is P20,000. Robin’s incremental borrowing rate is
14%.
The present value of an annuity due of 1 at:
12% 6.328 14% 5.946
The present value of 1 at:
12% 0.322 14% 0.270
What amount should Robin record as lease liability at the beginning of the lease term?
(a) P62,160 (b) P64,860 (c) P66,500 (d) P69,720 C

38. Oak Company leased equipment for its entire nine-year useful life, agreeing to pay P50,000 at
the start of the lease term on December 31, 2002, and P50,000 annually on each December
31, for the next eight years. The present value on December 31, 2002, of the nine lease
payments over the lease term, using the rate implicit in the lease which Oak knows to be
10%, was P316,500. The December 31, 2002 present value of the lease payments using
Oak’s incremental borrowing rate of 12% was P298,500. Oak made a timely second lease
payment. What amount should Oak report as capital lease liability in its December 31, 2003
balance sheet?
(a) P350,000 (b) P243,150 (d) P228,320 (d) P 0 B

39. The following information pertains to a sale and leaseback of equipment by Mega Company
on December 31, 2002:
Sales price P400,000
 Carrying amount 300,000
Monthly rental payment 3,250
Present value of lease payments 36,900
Estimated remaining life 25 years
Lease term 1 year
Implicit rate 12%
What amount of deferred gain on the sale should Mega report at December 31, 2002?
(a) P 0 (b) P36,900 (c) P63,100 (d) P100,000 A

40. On December 31, 2002, Lane sold equipment to Nail, and simultaneously leased it back for 12
years. Pertinent information at this date is as follows:
Sales price P480,000
Carrying amount 360,000
Estimated remaining economic life 15 years
At December 31, 2002, how much should Lane report as deferred revenue from the sale of
the equipment?
(a) P 0 (b) P110,000 (c) P112,000 (d) P120,000 D