Theories

1. C – Any residual value at the end of lease term

2. B – The present value of lease payments
3. D – The lessor records depreciation and lease revenue
4. C – The land is operating and the building is finance
5. B – Unguaranteed Residual Value
6. B – Net investment in the lease
7. A – Should be amortized over the lease term using the interest method
8. B – Shall be recognized over the lease term using the interest method
9. B – Be recognized in the normal way on the transaction
10. D – All of these statements are correct
11. C – Manufacturer profit from a sales type lease
12. C – The lessor recognizes a dealer profit at lease inception and interest revenue
over the lease term
13. A – According to relative fair value of the two elements
14. C – Recognition of the manufacturer or dealer profit at the inception of the lease
15. B – Cost of the asset plus initial direct cost paid by the lessor
16. B – 90 percent of the fair value of the underlying asset
17. C – The land is operating and the building is finance
18. B – The present value of lease payments
19. B – The transfer of the risks and rewards of ownership
20. B – Shall be recognized over the lease term using the interest method

Problem Solving

Questions 21-24
Required:
a. Lease Liability – 1/1/2020
b. Interest Expense – 2020
c. Interest Expense – 2023
d. Lease Liability – 12/31/202

Solution:
Annual Rental Payable – First 3 years 300,000
Multiply by PV of an ordinary annuity of 1 at 10% for 3 periods 2.49
PV for 1st 3 years 747,000

Annual Rental Payable – First 3 years 400,000

Multiply by of an ordinary annuity of 1 at 10% for 5 periods 3.79
PV for next 5 years 1,516,000
Multiply by PV of 1 at 10% for 3 periods 0.75
Present Value – 1/1/2020 1,137,000
PV for 1st 3 years 747,000
Lease Liability – 1/1/2020 1,884,000

Date Payment 10% Interest Principal Present Value

1/1/2020 P 1,884,000
12/31/2020 P 300,000 P 188,400 P 111,600 1,772,400
12/31/2021 300,000 177,240 122,760 1,649,640
12/31/2022 300,000 164,964 135,036 1,514,604
12/31/2023 400,000 151,460 248,540 1,266,064

Interest Expense – 2020 (10% of PV on 1/1/2020) 188,400

Interest Expense – 2023 (10% of PV on 12/31/2022) 151,460
Lease Liability – 12/31/2023 (PV on 12/31/2022 minus Principal
On 12/31/2023 = 1,514,604 – 248,540) 1,266,064

21. C – 1,884,000
22. A – 188,400
23. A – 151,460
24. B – 1,266,064

Questions 25-27
Required:
a. Annual Lease Payment
b. Total Annual Lease Payment
c. Unearned Interest Income of the Lessor at beg of current year

Solution:
Fair Value of the Building at inception of lease 2,949,600
Divide by PV of an ordinary annuity of 1 at 10% for 10 periods 6.145
Annual Lease Payment 480,000
Executory Costs 20,000
Total Annual Lease Payment 500,000

Annual Lease Payment 480,000

Economic Life of the Building 10
Gross Investment 4,800,000
Less: Net Investment equal to fair value 2,949,600
Unearned Interest Income 1,850,400

25. C – 480,000
26. D – 500,000
27. A – 1,850,400

Questions 28-32
Required:
a. Initial Lease Liability
 b. Cost of Right of Use Asset
c. Loss on Right Transferred
d. Interest Expense of the Seller-lessee for the Current Year
e. Net Annual Rent Income of the Buyer-lessor

Solution:
Fair Value of Building 20,000,000
Sale Price at below fair value 18,000,000
Excess Fair Value - prepayment 2,000,000

Annual Rental Payable 1,000,000

Multiply by PV of an ordinary annuity of 1 at 12% for 5 periods 2.49
Initial Lease Liability 3,600,000
Excess Fair Value 2,000,000
Total Lease Liability 5,600,000
Divide by Fair Value of Building / 20,000,000
Multiply by Carrying Amount of Building x 24,000,000
Cost of Right of Use Asset 6,720,000

Fair Value of Building 20,000,000

Less: Carrying Amount of Building 24,000,000
Loss 4,000,000

Fair Value of Building 20,000,000

Less: Right retained (Equal to Total Lease Liability) 5,600,000
Right transferred to Buyer-lessor 14,400,000
Divide by Fair Value of Building / 20,000,000
Multiply by Loss x 4,000,000
Loss on Right Transferred 2,880,000

Interest Expense for current year (12% of Initial Lease Liability) 432,000

Annual Rent Income 1,000,000

Less: Annual Depreciation (Sale Price at below fair value / useful life) 600,000
Net Annual Rent Income 400,000

28. A – 3,600,000
29. D – 6,720,000
30. B – 2,880,000
31. D – 432,000
32. A – 400,000