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CPA Financial Accounting and Reporting Far Quiz

CPA Financial Accounting and Reporting Far Quiz: Sales Type And Direct Financing Leases

Practice Sales Type And Direct Financing Leases in CPA Financial Accounting and Reporting Far with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

Question 1 / 20

0 of 20 answered

Under ASC 842, which of the following criteria, if met, requires a lessor to classify a lease as a sales-type lease?

Select an answer to continue

What this quiz covers

This quiz focuses on Sales Type And Direct Financing Leases, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA Financial Accounting and Reporting Far.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

Under ASC 842, which of the following criteria, if met, requires a lessor to classify a lease as a sales-type lease?

  1. The lease term is greater than 50% of the asset's remaining economic life.
  2. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term. (correct answer)
  3. The asset is specialized with no alternative use to the lessor.
  4. The present value of lease payments exceeds 75% of the asset's fair value.

Explanation: Under ASC 842-10-25-2, a lease is a sales-type lease if any one of five criteria is met, including transfer of ownership (Answer B), a purchase option the lessee is reasonably certain to exercise, a lease term covering the major part of the remaining economic life, present value of payments equaling or exceeding substantially all of the fair value, or a specialized asset with no alternative use to the lessor. Transfer of ownership is one of the clearest qualifying criteria. Answer B is correct. Answer A uses 50% for the lease term test - the standard 'major part' threshold is generally interpreted as 75% or more of remaining economic life. Answer C describes the specialized asset/no-alternative-use criterion, which is also one of the five qualifying criteria but is not what is described in Answer B. Answer D applies a 75% threshold to the present value test - the correct threshold under ASC 842 for 'substantially all' is generally interpreted as 90% or more of fair value.

Question 2

A lessor classifies a lease as a sales-type lease on January 1, Year 1. The net investment in the lease is 100,000andtheimplicitrateis6100,000 and the implicit rate is 6%. Annual lease payments of 100,000andtheimplicitrateis623,740 are due at year-end. What is interest income recognized in Year 1?

  1. $23,740
  2. $5,776
  3. $6,000 (correct answer)
  4. $17,740

Explanation: Interest income = Beginning net investment x Implicit rate = 100,000x6100,000 x 6% = 100,000x66,000. Answer C is correct. Answer A uses the full payment as income. Answer B subtracts interest from principal incorrectly. Answer D uses the payment minus interest as income.

Question 3

Under ASC 842, the lessor's 'net investment in the lease' for a sales-type or direct financing lease consists of:

  1. The present value of lease payments not yet received plus the present value of any unguaranteed residual value. (correct answer)
  2. The gross amount of future lease payments only.
  3. The carrying amount of the underlying asset on the lessor's books.
  4. The fair value of the underlying asset at lease commencement.

Explanation: The net investment in the lease is the present value of (1) the lease payments receivable (including guaranteed residual value) and (2) the unguaranteed residual value accruing to the lessor, both discounted at the rate implicit in the lease. Answer A is correct. Answer B uses undiscounted gross payments. Answer C uses the carrying amount, which is relevant for computing selling profit but is not the definition of net investment. Answer D uses fair value at commencement, which may equal net investment but is not the definitional formula.

Question 4

A lessor has a direct financing lease with annual payments of 30,000for4years,beginningJanuary1,Year1(paymentsatyear−end).Theimplicitrateis830,000 for 4 years, beginning January 1, Year 1 (payments at year-end). The implicit rate is 8% and the PV of payments is 30,000for4years,beginningJanuary1,Year1(paymentsatyear−end).Theimplicitrateis899,364. What is the net investment at the beginning of Year 2?

  1. $99,364
  2. $69,364
  3. $107,313
  4. $77,313 (correct answer)

Explanation: Beginning net investment = 99,364.Year1interestincome=99,364. Year 1 interest income = 99,364.Year1interestincome=99,364 x 8% = 7,949.Principalreduction=7,949. Principal reduction = 7,949.Principalreduction=30,000 - 7,949=7,949 = 7,949=22,051. Net investment at beginning of Year 2 = 99,364−99,364 - 99,364−22,051 = $77,313. Answer D is correct. Answer A is the original investment. Answer B subtracts the full payment without adding interest. Answer C adds interest to the investment without deducting the payment.

Question 5

A lessor enters a direct financing lease on January 1, Year 1. Asset cost: 150,000.Totalundiscountedleasepayments:150,000. Total undiscounted lease payments: 150,000.Totalundiscountedleasepayments:180,000. Unearned interest income at commencement: $30,000. How is the lease receivable presented on the January 1, Year 1 balance sheet?

  1. Lease receivable $180,000 with no contra account.
  2. Net investment $150,000 presented as a single line.
  3. Lease receivable 180,000lessunearnedinterestincome(180,000 less unearned interest income (180,000lessunearnedinterestincome(30,000) = net investment $150,000. (correct answer)
  4. Lease receivable $30,000 representing only unearned income.

Explanation: 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.

Question 6

Under ASC 842, a lessor recognizes revenue and cost of goods sold at commencement of a sales-type lease when:

  1. The fair value of the underlying asset equals the sum of the present value of lease payments and any unguaranteed residual value. (correct answer)
  2. The lessee has made its first payment under the lease.
  3. The lease term covers more than 75% of the asset's useful life.
  4. The lessor obtains a guarantee of the residual value from a creditworthy third party.

Explanation: At commencement of a sales-type lease, the lessor derecognizes the underlying asset and recognizes revenue (equal to the net investment in the lease, or fair value if lower) and cost of sales (equal to the carrying amount of the asset less PV of unguaranteed residual). The accounting mirrors a sale. The condition is met when commencement criteria are satisfied and the lease is classified as sales-type - not tied to first payment (B), a percentage threshold (C), or a guarantee requirement (D). Answer A describes the recognition framework. Answers B, C, and D are not commencement recognition triggers.

Question 7

Under ASC 842, initial direct costs in a direct financing lease are treated as:

  1. Expensed immediately at commencement.
  2. Added to the cost of goods sold recognized at commencement.
  3. Added to the net investment in the lease and effectively amortized as a yield adjustment over the lease term. (correct answer)
  4. Capitalized separately and amortized on a straight-line basis.

Explanation: In a direct financing lease (where no selling profit is recognized), initial direct costs are added to the net investment in the lease. This reduces the effective yield and results in the costs being amortized into interest income over the lease term. Answer C is correct. Expensing at commencement (A) applies to sales-type leases with a selling profit. Adding to COGS (B) has no basis for direct financing leases. Straight-line amortization as a separate asset (D) is not the ASC 842 treatment.

Question 8

A lessor's sales-type lease: asset carrying amount 95,000,PVofleasepayments95,000, PV of lease payments 95,000,PVofleasepayments112,000, PV of unguaranteed residual value $8,000. What is the cost of sales recognized at commencement?

  1. $112,000
  2. $95,000
  3. $103,000
  4. $87,000 (correct answer)

Explanation: Cost of sales = Carrying amount of asset - PV of unguaranteed residual = 95,000−95,000 - 95,000−8,000 = $87,000. The lessor retains the economic interest in the unguaranteed residual, so it is excluded from the cost transferred. Answer D is correct. Answer B uses full carrying amount without deducting unguaranteed residual. Answer A uses the lease payment PV. Answer C adds rather than subtracts the unguaranteed residual.

Question 9

A lessor records interest income on a sales-type lease using which method?

  1. Straight-line over the lease term.
  2. Sum-of-the-years'-digits based on the net investment balance.
  3. Effective interest method, applying the implicit rate to the beginning net investment each period. (correct answer)
  4. Units-of-production based on asset usage.

Explanation: 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.

Question 10

A lessor's sales-type lease produces revenue of 110,000andcostofsalesof110,000 and cost of sales of 110,000andcostofsalesof85,000 at commencement. What gross profit does the lessor recognize from the lease at inception?

  1. $25,000 (correct answer)
  2. $110,000
  3. $85,000
  4. $195,000

Explanation: Gross profit = Revenue - Cost of sales = 110,000−110,000 - 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.

Question 11

Under ASC 842, what happens to the unguaranteed residual value in a sales-type lease over the lease term?

  1. It is recognized as revenue in the final year of the lease.
  2. It is depreciated by the lessor over the lease term.
  3. It is deducted from the net investment at commencement and not accreted.
  4. It accretes back to its expected value over the lease term as part of the net investment, recognized as interest income. (correct answer)

Explanation: 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.

Question 12

A lessor enters a direct financing lease: net investment 80,000,implicitrate1080,000, implicit rate 10%, annual payments 80,000,implicitrate1025,238 at year-end. What is net investment at the end of Year 2?

  1. $80,000
  2. $62,762
  3. $54,762
  4. $43,800 (correct answer)

Explanation: Year 1: Interest = 80,000x1080,000 x 10% = 80,000x108,000. Principal = 25,238−25,238 - 25,238−8,000 = 17,238.NIendY1=17,238. NI end Y1 = 17,238.NIendY1=62,762. Year 2: Interest = 62,762x1062,762 x 10% = 62,762x106,276. Principal = 25,238−25,238 - 25,238−6,276 = 18,962.NIendY2=18,962. NI end Y2 = 18,962.NIendY2=62,762 - 18,962=18,962 = 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.

Question 13

Under ASC 842, which of the following costs incurred by the lessor in originating a sales-type lease are expensed at lease commencement?

  1. Deferred and amortized over the lease term.
  2. Expensed immediately at commencement since a selling profit is recognized. (correct answer)
  3. Added to the net investment in the lease.
  4. Capitalized as an intangible asset and amortized over the lease term.

Explanation: Under ASC 842, initial direct costs incurred by a lessor in a sales-type lease where a selling profit is present are expensed at commencement (because recognizing selling profit implies the transaction is a sale). Answer B is correct. Deferral (A) and addition to net investment (C) apply to direct financing leases where initial direct costs are included in the net investment. Capitalization as an intangible (D) has no basis in ASC 842.

Question 14

On January 1, Year 1, a lessor enters a sales-type lease. The asset's cost is 80,000,itsfairvalueis80,000, its fair value is 80,000,itsfairvalueis95,000, and the present value of lease payments is 95,000.Theleasetermis5yearswithannualpaymentsof95,000. The lease term is 5 years with annual payments of 95,000.Theleasetermis5yearswithannualpaymentsof23,000 due at year-end. What is the selling profit recognized by the lessor at lease commencement?

  1. $15,000 (correct answer)
  2. $95,000
  3. $23,000
  4. $0

Explanation: 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(fairvalue/PVofleasepayments)−95,000 (fair value / PV of lease payments) - 95,000(fairvalue/PVofleasepayments)−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.

Question 15

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?

  1. 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. (correct answer)
  2. The lease transfers the risks and rewards of ownership to the lessee.
  3. The lessee has a purchase option that it is reasonably certain to exercise.
  4. The underlying asset has no alternative use to the lessor at the end of the lease term.

Explanation: 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.

Question 16

A lessor has a 4-year sales-type lease. Net investment at the start of Year 3 is 42,000.Implicitrateis942,000. Implicit rate is 9%. Annual payment is 42,000.Implicitrateis915,000 at year-end. What is interest income in Year 3?

  1. $15,000
  2. $11,220
  3. $3,780 (correct answer)
  4. $6,000

Explanation: Interest income Year 3 = Beginning net investment x implicit rate = 42,000x942,000 x 9% = 42,000x93,780. Answer C is correct. Answer A uses the full payment as income. Answer B is the principal portion (15,000−15,000 - 15,000−3,780). Answer D applies an incorrect rate.

Question 17

Under ASC 842, which of the following correctly describes the collectibility criterion for direct financing lease classification?

  1. Collection must be virtually certain before a direct financing lease can be recognized.
  2. It must be probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee. (correct answer)
  3. Collection must be assessed only at the inception of the lease, not subsequently.
  4. The collectibility criterion applies only to sales-type leases, not direct financing leases.

Explanation: 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.

Question 18

A sales-type lease has a lease term of 5 years, annual payments of 20,000,animplicitrateof720,000, an implicit rate of 7%, and an unguaranteed residual value of 20,000,animplicitrateof710,000 at end of Year 5. The PV of payments at 7% for 5 years is 82,004andthePVof82,004 and the PV of 82,004andthePVof10,000 at 7% for 5 years is $7,130. What is the net investment in the lease at commencement?

  1. $100,000
  2. $82,004
  3. $92,004
  4. $89,134 (correct answer)

Explanation: Net investment = PV of lease payments + PV of unguaranteed residual value = 82,004+82,004 + 82,004+7,130 = 89,134.AnswerDiscorrect.AnswerA(89,134. Answer D is correct. Answer A (89,134.AnswerDiscorrect.AnswerA(100,000) uses the undiscounted total payments only (5 x 20,000),ignoringboththepresentvaluefactorandtheresidualvalue.AnswerB(20,000), ignoring both the present value factor and the residual value. Answer B (20,000),ignoringboththepresentvaluefactorandtheresidualvalue.AnswerB(82,004) includes only the PV of lease payments and omits the PV of the unguaranteed residual value. Answer C (92,004)addstheundiscountedresidualvalue(92,004) adds the undiscounted residual value (92,004)addstheundiscountedresidualvalue(10,000) rather than its present value ($7,130), overstating the net investment.

Question 19

Under ASC 842, a direct financing lease differs from a sales-type lease primarily in that:

  1. A direct financing lease transfers ownership; a sales-type lease does not.
  2. A direct financing lease produces no selling profit at commencement; only interest income is recognized over the lease term. (correct answer)
  3. A direct financing lease is used only for real estate; a sales-type lease applies to equipment.
  4. A direct financing lease requires operating lease presentation on the lessor's balance sheet.

Explanation: In a direct financing lease, the fair value of the underlying asset equals its carrying amount at commencement, so no selling profit arises. The lessor recognizes only interest income over the lease term using the effective interest method. Answer B is correct. Answer A misstates which type transfers ownership - both types can involve ownership transfer or other qualifying criteria. Answer C introduces asset-type restrictions that do not exist under ASC 842. Answer D incorrectly describes a direct financing lease as an operating lease.

Question 20

Under ASC 842, which of the following correctly describes the income statement presentation for a sales-type lease in the period of commencement?

  1. Revenue (net investment), cost of sales (carrying amount less PV of unguaranteed residual), and interest income over the lease term. (correct answer)
  2. Only interest income; no revenue or cost of sales is recognized.
  3. Operating lease income on a straight-line basis over the lease term.
  4. Revenue equal to total undiscounted lease payments at commencement.

Explanation: 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.