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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

(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’s journal entries for the first year.

(Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for \(900,000 by Young Co. The machine is expected to have an 8-year life with no salvage value. It is to be depreciated on a straight-line basis. The machine was leased to St. Leger Inc. on January 1, 2017, at an annual rental of \)210,000. Other relevant information is as follows.

  1. The lease term is for 3 years.
  2. Young Co. incurred maintenance and other executory costs of \(25,000 in 2017 related to this lease.
  3. The machine could have been sold by Young Co. for \)940,000 instead of leasing it.
  4. St. Leger is required to pay a rent security deposit of \(35,000 and to prepay the last month’s rent of \)17,500.

Instructions

(a) How much should Young Co. report as income before income tax on this lease for 2017?

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?

(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.

  1. The lease arrangement is for 10 years.
  2. The leased building cost \(4,500,000 and was purchased for cash on January 1, 2017.
  3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
  4. Lease payments are \)275,000 per year and are made at the end of the year.
  5. Property tax expense of \(85,000 and insurance expense of \)10,000 on the building were incurred by Nelson in the first year. Payment on these two items was made at the end of the year.
  6. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

  1. Prepare the journal entries that Nelson Co. should make in 2017.

(Lessee Entries, Capital Lease with Monthly Payments) Shapiro Inc. was incorporated in 2016 to operate as a computer software service firm with an accounting fiscal year ending August 31. Shapiro’s primary product is a sophisticated online inventory-control system; its customers pay a fixed fee plus a usage charge for using the system.

Shapiro has leased a large, Alpha-3 computer system from the manufacturer. The lease calls for a monthly rental of \(40,000 for the 144 months (12 years) of the lease term. The estimated useful life of the computer is 15 years.

Each scheduled monthly rental payment includes \)3,000 for full-service maintenance on the computer to be performed by the manufacturer. All rentals are payable on the first day of the month beginning with August 1, 2017, the date the computer was installed and the lease agreement was signed. The lease is noncancelable for its 12-year term, and it is secured only by the manufacturer’s chattel lien on the Alpha-3 system.

This lease is to be accounted for as a capital lease by Shapiro, and it will be depreciated by the straight-line method with no expected salvage value. Borrowed funds for this type of transaction would cost Shapiro 12% per year (1% per month). Following is a schedule of the present value of \(1 for selected periods discounted at 1% per period when payments are made at the beginning of each period.

Periods Present (months)

Present Value of \)1 per Period Discounted at 1% per Period

1

1.000

2

1.990

3

2.970

143

76.658

144

76.899

Instructions

Prepare all entries Shapiro should have made in its accounting records during August 2017 relating to this lease. Give full explanations and show supporting computations for each entry. Remember, August 31, 2017, is the end of Shapiro’s fiscal accounting period and it will be preparing financial statements on that date. Do not prepare closing entries.
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