- A lessor enters a direct financing lease: net investment $80,000, implicit rate 10%, annual payments $25,238 at year-end. What is net investment at the end of Year 2?
Answer: $43,800
Year 1: Interest = $80,000 x 10% = $8,000. Principal = $25,238 - $8,000 = $17,238. NI end Y1 = $62,762. Year 2: Interest = $62,762 x 10% = $6,276. Principal = $25,238 - $6,276 = $18,962. NI end Y2 = $62,762 - $18,962 = $43,800. Answer D is correct. Answer A is the original investment. Answer B is end of Year 1. Answer C deducts two full payments from the original without accounting for interest.
- On January 1, Year 1, a lessor enters a sales-type lease. The asset's cost is $80,000, its fair value is $95,000, and the present value of lease payments is $95,000. The lease term is 5 years with annual payments of $23,000 due at year-end. What is the selling profit recognized by the lessor at lease commencement?
Answer: $15,000
In a sales-type lease, the lessor recognizes a selling profit equal to the net investment in the lease less the carrying amount of the underlying asset: $95,000 (fair value / PV of lease payments) - $80,000 (cost) = $15,000. Answer A is correct. Answer B records the full lease receivable as profit. Answer C uses one payment amount. Answer D applies to direct financing leases where no profit is recognized at commencement.
- What is the effective semiannual interest rate that should be used to recognize interest income over the lease term?
Answer: 6.85%
When initial direct costs are incurred in a direct financing lease, the effective interest rate must be recalculated to include these costs in the investment base. The total investment equals the present value of lease payments ($25,000 × 8.53020 = $213,255) plus the present value of the purchase option ($10,000 × 0.55839 = $5,584) plus initial direct costs ($18,000), totaling $236,839. The effective semiannual rate that equates this investment to the contractual cash flows is approximately 6.85%. Choice A ignores the impact of initial direct costs on the effective rate.
- Under ASC 842, which of the following is required for a lessor to classify a lease as a direct financing lease rather than an operating lease?
Answer: The present value of lease payments plus any guaranteed residual value equals substantially all of the fair value of the underlying asset, and collection is probable.
A direct financing lease requires that (1) the PV of payments plus guaranteed residual equals substantially all of the fair value (the 'substantially all' criterion), and (2) it is probable that the lessor will collect the payments. Importantly, the lease must not meet any of the five sales-type criteria. Answer A is correct. Answer B describes the old IAS 17 approach. Answer C would trigger sales-type classification, not direct financing. Answer D (no alternative use) is a sales-type criterion.
- Under ASC 842, what happens to the unguaranteed residual value in a sales-type lease over the lease term?
Answer: It accretes back to its expected value over the lease term as part of the net investment, recognized as interest income.
The unguaranteed residual value is included in the net investment at its present value at commencement. Over the lease term, as the implicit rate is applied to the net investment, the PV of the unguaranteed residual accretes toward its nominal value at the end of the lease. This accretion is captured within interest income. Answer D is correct. Answer A defers recognition to the final year only. Answer B applies depreciation, which is relevant to operating leases. Answer C excludes accretion.
- For a direct financing lease with quarterly payments where the next four payments will be received within 12 months, how should the net investment be classified on the December 31, 2024 balance sheet?
Answer: Current portion equal to principal reductions from payments due within one year, remainder as non-current
The current portion of net investment in leases should include only the principal portion of payments to be received within one year, not the interest portion. This follows the same principle as other long-term receivables where only principal reductions are classified as current. Choice A incorrectly classifies the entire investment as current. Choice B incorrectly ignores the current portion. Choice D incorrectly includes interest portions in current assets.
- Under ASC 842, which of the following distinguishes a sales-type lease from a direct financing lease from the lessor's perspective at commencement?
Answer: A sales-type lease recognizes selling profit (or loss) at commencement; a direct financing lease does not.
The primary distinction is that a sales-type lease recognizes a selling profit (or dealer's margin) at commencement because the fair value of the asset differs from its carrying amount. A direct financing lease arises when fair value equals carrying amount, so no selling profit exists at commencement. Both types derecognize the underlying asset and use the effective interest method. Answer B is correct. Answer A incorrectly differentiates by income recognition method. Answer C introduces a residual guarantee requirement that does not define this distinction. Answer D is incorrect - both types derecognize the asset.
- What is the combined gross profit that Global Equipment should recognize from both leases on January 1, 2024?
Answer: $60,000
Sales-type lease (A): Gross profit = Sales revenue - Cost of goods sold. Sales revenue is the lower of fair value ($400,000) or PV of lease payments ($380,000) = $380,000. COGS = $320,000. Gross profit = $380,000 - $320,000 = $60,000. Direct financing lease (B): No gross profit is recognized at commencement; profit is recognized over the lease term as interest income. Total gross profit = $60,000. Choice A incorrectly reduces profit by initial direct costs. Choice C uses fair value instead of PV for Lease A. Choice D incorrectly includes profit from both leases.
- A lessor's sales-type lease produces revenue of $110,000 and cost of sales of $85,000 at commencement. What gross profit does the lessor recognize from the lease at inception?
Answer: $25,000
Gross profit = Revenue - Cost of sales = $110,000 - $85,000 = $25,000. Answer A is correct. Answer B uses only revenue. Answer C uses only cost of sales. Answer D adds revenue and cost.
- What journal entry should Tech Solutions record on January 1, 2024, to recognize the cost of goods sold?
Answer: Dr. Cost of Goods Sold $150,000; Cr. Equipment $150,000
In a sales-type lease, cost of goods sold equals the carrying amount of the leased asset ($150,000). Initial direct costs are expensed separately in sales-type leases, not included in COGS. The entry removes the asset at its carrying amount. Choice B incorrectly includes initial direct costs in COGS. Choice C treats initial direct costs as part of asset cost. Choice D incorrectly reduces COGS and capitalizes initial direct costs.
- Which of the following statements correctly describes the lessor's accounting for the underlying asset in a sales-type lease at commencement?
Answer: The lessor derecognizes the underlying asset and records a net investment in the lease.
In a sales-type lease, the economic substance is a sale. At commencement, the lessor removes the underlying asset from its balance sheet and records a net investment in the lease (the PV of future lease payments and unguaranteed residual). Answer B is correct. Answer A describes operating lease treatment where the asset is retained. Answer C records the receivable at carrying amount rather than PV. Answer D omits the required net investment recording.
- A lessor enters a direct financing lease on January 1, Year 1. Asset cost: $150,000. Total undiscounted lease payments: $180,000. Unearned interest income at commencement: $30,000. How is the lease receivable presented on the January 1, Year 1 balance sheet?
Answer: Lease receivable $180,000 less unearned interest income ($30,000) = net investment $150,000.
In a direct financing lease, the lessor records the gross receivable at the total undiscounted payments and offsets unearned interest income as a contra account, yielding a net investment equal to the present value of payments. Answer C is correct. Answer A omits the contra account. Answer B presents only the net amount without the gross receivable disclosure. Answer D records only the unearned income component.
- Under ASC 842, which of the following correctly describes the income statement presentation for a sales-type lease in the period of commencement?
Answer: Revenue (net investment), cost of sales (carrying amount less PV of unguaranteed residual), and interest income over the lease term.
A sales-type lease produces three income statement elements: (1) revenue at commencement equal to the net investment in the lease (or fair value if lower), (2) cost of sales equal to the carrying amount less PV of unguaranteed residual, and (3) interest income recognized over the lease term using the effective interest method. Answer A is correct. Answer B describes a direct financing lease. Answer C describes operating lease treatment. Answer D uses undiscounted payments rather than PV.
- A lessor records interest income on a sales-type lease using which method?
Answer: Effective interest method, applying the implicit rate to the beginning net investment each period.
Under ASC 842, interest income on both sales-type and direct financing leases is recognized using the effective interest method. The implicit rate is applied to the beginning-of-period net investment to calculate interest income, and principal is reduced by the difference between the payment received and interest earned. Answer C is correct. Straight-line (A), sum-of-the-years'-digits (B), and units-of-production (D) are not prescribed methods for lease interest income under ASC 842.
- A sales-type lease has a lease term of 5 years, annual payments of $20,000, an implicit rate of 7%, and an unguaranteed residual value of $10,000 at end of Year 5. The PV of payments at 7% for 5 years is $82,004 and the PV of $10,000 at 7% for 5 years is $7,130. What is the net investment in the lease at commencement?
Answer: $89,134
Net investment = PV of lease payments + PV of unguaranteed residual value = $82,004 + $7,130 = $89,134. Answer D is correct. Answer A ($100,000) uses the undiscounted total payments only (5 x $20,000), ignoring both the present value factor and the residual value. Answer B ($82,004) includes only the PV of lease payments and omits the PV of the unguaranteed residual value. Answer C ($92,004) adds the undiscounted residual value ($10,000) rather than its present value ($7,130), overstating the net investment.
- A sales-type lease requires the lessor to present the net investment in the lease on the balance sheet. Which of the following correctly describes the balance sheet classification?
Answer: Split between current and noncurrent based on when lease payments are expected to be received within and beyond 12 months.
The net investment in a lease is classified on the balance sheet consistent with other financial assets - the portion due within 12 months is current and the remainder is noncurrent. Answer C is correct. Answer A mandates noncurrent regardless of payment timing. Answer B mandates all current. Answer D uses undiscounted amounts and mandates current classification.
- What is the net investment in the lease immediately after the lease commencement?
Answer: $281,405
In a direct financing lease, the net investment equals the present value of lease payments plus initial direct costs. PV of payments = $85,000 × 3.16987 (PV ordinary annuity, 4 periods, 10%) = $269,405. Adding initial direct costs: $269,405 + $12,000 = $281,405. Choice A omits the required addition of initial direct costs. Choice C uses an incorrect calculation base. Choice D incorrectly uses the asset's fair value.
- Under ASC 842, a lease that does not meet any of the five sales-type lease criteria but where the present value of lease payments and any guaranteed residual value equals substantially all of the fair value of the underlying asset may qualify as:
Answer: A direct financing lease, if the lease also meets collectibility criteria.
Under ASC 842, a direct financing lease arises when the lease does not meet the sales-type criteria but: (1) the PV of lease payments plus any guaranteed residual equals substantially all of the fair value, and (2) it is probable that the lessor will collect the payments plus any residual. Answer D is correct. Answer A (operating lease) applies when no sales-type or direct financing criteria are met. Answer B (leveraged lease) was eliminated under ASC 842. Answer C misapplies the sales-type classification.
- Under ASC 842, which of the following correctly describes the collectibility criterion for direct financing lease classification?
Answer: It must be probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee.
Under ASC 842-10-25-3, a lease qualifies as a direct financing lease (in part) when it is probable that the lessor will collect the lease payments plus any amount to satisfy a residual value guarantee. This is the collectibility criterion. Answer B is correct. Answer A requires virtual certainty, which is a higher threshold. Answer C is incorrect - collectibility is reassessed. Answer D misapplies the criterion to only sales-type leases.
- What is the total amount that should be recognized in income (excluding interest income) by Logistics Leasing on September 1, 2024?
Answer: $18,000
In a sales-type lease, income recognized at commencement includes gross profit minus initial direct costs (which are expensed immediately). Sales revenue = lower of fair value ($220,000) or PV of lease payments. PV = $80,000 × 2.78326 (PV annuity due, 3 periods, 8%) = $222,661, so use fair value of $220,000. Gross profit = $220,000 - $190,000 = $30,000. Less initial direct costs expensed = $30,000 - $12,000 = $18,000 net income effect. Choice B is gross profit before initial direct costs. Choice C incorrectly adds initial direct costs. Choice D has no basis.
