ACCT 311 Homework Assignment #7

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Homework Assignment #7

1. On December 31, Year One, Ace signs a lease to use a truck for four years. The truck has a current value of $58,600. Four annual payments of $10,000 are to be paid with the first made on December 31, Year One. After that time, the truck (with an expected life of eight years) will be returned to the lessor. Ace has an incremental borrowing rate of 6 percent. The lessor has an implicit annual interest rate of 8 percent built into the contract. Ace is aware of this implicit rate. The present value of a four-year annuity due of $10,000 at a 6 percent annual rate is $36,700. The present value of a four-year annuity due of $10,000 at an 8 percent annual rate is $35,770. What liability should Ace report on its December 31, Year One, balance sheet?

1. $0

2. $10,000

3. $25,770

4. $26,700

2. A company leases a machine on January 1, Year One for five years which call for annual payments of $4,000 for the first year and then $10,000 per year after that. The present value of these payments based on a reasonable interest rate of 10 percent is assumed to be $38,000. This lease is an operating lease. How much expense will the company recognize for Year One?

1. $4,000

2. $7,600

3. $8,800

4. $11,400

3. On January 1, Year One, Owens buys a large warehouse for $700,000 which it immediately sells to National Financing for $800,000. The warehouse has an expected life of 10 years. Owens immediately signs a contract to lease the warehouse back for its own use. This lease is for 10 years with payments of $120,000 per year. The first payment is made immediately. Assume that these payments were computed using a 10 percent annual interest rate. Which of the following statements is true?

1. The $100,000 gain on the original sale must be recognized by Owens immediately.

2. The $100,000 gain on the original sale will be recorded by Owens as other comprehensive income.

3. The $100,000 gain on the original sale will be deferred until the end of the lease and then recognized as a gain.

4. The $100,000 gain on the original sale will be deferred and then written off each year as a reduction in the depreciation expense on the leased warehouse.

4. The Turpen Company buys a machine for $30,000. Normally, the machine would be sold to a customer for $42,000. However, in hopes of expanding the number of available customers, Turpen leases the machine for 4 years to the Royal Corporation. The accountants for the Turpen Company are currently studying how this lease should be recorded for financial reporting purposes. Which of the following statements is true?

1. Because this property is normally sold, the lease contract must be recorded as a capital lease by Turpen.

2. Because this property is normally sold, the lessee (Royal) must report it as a sales-type lease.

3. If the machine has an expected life of five years, then both parties must report the transaction as a capital lease.

4. If the lease contract gives Royal the option to buy the machine at the end of four years, then both parties must report the transaction as a capital lease

5. On January 1, Year One, Green Company leases a machine for four years. Because Green is a relatively new business and is struggling with its cash flows, the lessor sets the payments as $10,000 per year for the first two years and $20,000 for the last two years. These payments were computed based on an implicit interest rate of 10 percent per year. The contract does not meet any of the four criteria to be reported as a capital lease. What amount of expense should Green recognize in Year Two?

1. $5,000

2. $6,000

3. $10,000

4. $15,000

6. Boeing builds a plane for $10 million that it normally sells for $15 million. However, on January 1, Year One, Boeing leases this plane to Delta for $3 million per year for 7 years (the entire expected life of the plane). Which of the following answers is correct?

1. To Boeing, this lease qualifies as a direct financing lease.

2. To Delta, this lease qualifies as a sales type lease.

3. Boeing will recognize a $5 million profit when the lease is signed.

4. Delta recognizes rent expense of $3 million in Year One.

7. A lessor leases property to a lessee. This contract meets the requirements for being recorded as a capital lease. The lessor is trying to determine whether this lease should be accounted for as a direct financing lease or a sales-type lease. Which of the following statements is not true?

1. The total amount of profit will be more if it is a sales-type lease than if it is a direct financing lease.

2. If the lessor is either a manufacturer or a dealer in this particular item, the lease is recorded as a sales-type lease.

3. In a direct financing lease, all profit is recognized as interest revenue over the life of the lease.

4. In a sales-type lease, a normal amount of profit is recognized at the time that the contract begins.

8. The Jones Company only buys and then leases assets. It is neither a manufacturer nor a dealer of any items. On January 1, Year One, Jones buys equipment for $34,000 in cash. This asset is immediately leased for 8 years, its entire life. Annual payments are $5,800 to be made each January 1 beginning on January 1, Year One. Assume that the implicit interest rate profit built into the contract by Jones was 10 percent. However, the lessee’s incremental borrowing rate was only 8 percent per year. What amount of income should Jones recognize for Year One?

1. $2,256

2. $2,820

3. $3,400

4. $4,060

9. Danville Corporation buys a truck for $52,000 and leases it to Viceroy for 8 years. At the end of that time, Viceroy can buy the truck for $7,000 in cash. Which of the following is not true?

1. If this purchase option is viewed as a bargain, Danville should record the $7,000 as a future cash flow in accounting for the lease even though it is not guaranteed.

2. Unless the purchase option is viewed as a bargain, Danville cannot account for this lease as a capital lease.

3. The purchase option cannot be viewed as a bargain unless it is significantly below the expected fair value of the truck on that date.

4. If this purchase option is viewed as a bargain, Danville’s profit to be recognized in the first year will be increased.

10. On January 1, Year One, AnnaLee Company buys a warehouse for $800,000 and is in the process of leasing it to Ziton Company for four out of its five year life. AnnaLee normally has an implicit rate of 10 percent whereas Ziton has an incremental borrowing rate of 8 percent. Assume the payment amounts have been computed appropriately. For these computations assume that the present value of $1 in four years at 8 percent annual interest is .72 and at 10 percent is .66. Assume that the present value of an ordinary annuity of $1 for four years at 8 percent annual interest is 3.27 and at 10 percent is 3.10. Assume that the present value of annuity due of $1 for four years at 8 percent annual interest is 3.55 and at 10 percent is 3.46. Payments are set to be $210,000 per year with the payments to begin immediately. The lessee has an option to buy the asset at the end of the lease for $70,000 which is viewed as a bargain. It is a direct financing lease. What is the total increase in net income that AnnaLee will report in Year One?

1. $59,000

2. $62,000

3. $67,000

4. $70,000

11. The Ace Company buys cars and sells them at 20 percent above cost. On January 1, Year One, the company buys a car for $40,000 and immediately leases it for its entire six year life. Assume that annual payments for this lease will be $10,000 per year starting on January 1, Year One. This payment amount was based on an implicit interest rate of 10 percent. How much interest revenue will Ace recognize for Year One?

1. $3,000

2. $3,800

3. $4,000

4. $4,800

12. On December 31, Year One, the Reinhardt Company owns a tractor and leases it to the Smith Company. The tractor has a life of five years but the lease is only for four years. Which of the following statements is NOT true for the Reinhardt Company?

1. If this is a sales-type lease, profit will be recognized immediately with interest revenue then recognized over the next four years.

2. If this is a direct financing lease, no profit is recognized immediately but interest revenue is recognized over the next four years.

3. Based on the information, this might be an operating lease or it might be a capital lease.

4. Reinhardt must base the computation of interest revenue on the imputed interest rate built into the contract.

13. Jones buys widgets and marks them up 20 percent and sells them. On January 1, Year One, Jones buys a widget for $30,000 but this time Jones leases the item to another company for its entire 10 year life. Jones sets the annual payments (which begin immediately) at $5,300 in order to earn an annual interest rate of 10 percent. How much will net income increase for Jones during Year One because of this lease?

1. $2,470

2. $3,000

3. $6,000

4. $9,070

14. On December 31, Year One, a company leases equipment for 8 years, its entire life. Payments are $10,000 per year on December 31 with the first one made immediately. The present value of these payments at the lessee’s incremental borrowing rate of 10 percent per year is assumed to be $58,000. On the December 31, Year One balance sheet, what should this lessee report as its current liability for this lease?

1. $0

2. $5,200

3. $6,000

4. $10,000

15. On January 1, Year One, a company leases equipment for 8 years although the equipment has a life of 10 years. At the end of that time, title to this property will be conveyed to the lessee. Payments are $10,000 per year on January 1 with the first one made immediately. The present value of these payments at the lessee’s incremental borrowing rate of 10 percent per year is assumed to be $58,000. What amount of depreciation expense should the lessee recognize for Year One?

1. $0

2. $5,800

3. $6,000

4. $7,250

16. On January 1, Year One, the Lenoir Company leases equipment from Burke Corporation for eight years which is the entire life of the asset. It will be discarded at the end of that period. For Burke, this transaction is a direct financing leases using an implicit interest rate of 10 percent. Based on that rate, the annual payments are $12,000 beginning immediately. Lenoir is unaware of Burke’s implicit but has an incremental borrowing rate of 8 percent. Assume that the present value of an ordinary annuity for eight years at an annual interest rate of 8 percent is 5.75 and at 10 percent is 5.33 whereas the present value of an annuity due for eight years at an annual interest rate of 8 percent is 6.21 and at 10 percent is 5.87. If the effective rate method is applied, what amount of interest expense should Lenoir report for Year Two? (Round to the nearest dollar.)

1. $4,089

2. $4,442

3. $4,516

4. $5,070

17. On January 1, Year One, Alexander Company buys a warehouse for $800,000 and is in the process of leasing it to Zebra Company for four out of its five year life. It has no expected residual value after five years. Alexander normally has an implicit rate of 10 percent whereas Zebra has an incremental borrowing rate of 8 percent. Assume the payment amounts have been computed appropriately. For these computations assume that the present value of $1 in four years at 8 percent annual interest is .72 and at 10 percent is .66. Assume that the present value of an ordinary annuity of $1 for four years at 8 percent annual interest is 3.27 and at 10 percent is 3.10. Assume that the present value of annuity due of $1 for four years at 8 percent annual interest is 3.55 and at 10 percent is 3.46. Payments are set to be $300,000 per year with the payments to begin immediately. No residual value is assumed at the end of the lease and there is no option to buy the warehouse. It is a sales type lease. What is the total decrease in net income that Zebra will report in Year One?

1. $287,510

2. $296,570

3. $315,620

4. $327,450

18. The Wasala Corporation leases an airplane on January 1, Year One for eight years for payments of $20,000 per year beginning immediately. The plane has an expected life of 10 years. The prime rate of interest is 6 percent but Wasala has an incremental borrowing rate of 8 percent. The present value of an ordinary annuity of $1 at 6 percent for 8 years is 6.22 and the present value of an ordinary annuity of $1 at 8 percent for 8 years is 5.75. The present value of an annuity due of $1 at 6 percent for 8 years is 6.58 and the present value of an annuity due of $1 at 8 percent for 8 years is 6.19. At the end of 8 years, title to the airplane will be conveyed to Wasala. How much expense should Wasala recognize in Year Two? (round to the nearest dollar)

1. $17,880

2. $18,108

3. $19,058

4. $19,748

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