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Test Bank for Financial Accounting for MBAs by Easton
Test Bank for Financial Accounting for MBAs by Easton
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Test Bank for Financial Accounting Section 1for MBAs by Easton
Leases, Pensions,
and Income Taxes
Learning Objectives – Coverage by question
True/False Multiple Choice
LO1 – Analyze and interpret lease disclosures. 1-5 1-8
LO2 – Analyze and interpret pension disclosures. 6-9 9-19
LO3 – Analyze and interpret income tax reporting. 10, 11 20-25
LO4 – Use a calculator and present value tables for
3, 5-8
lease calculations (Appendix 10A).
LO5 – Examine pension expense in more detail
(Appendix 10B).
LO6 – Examine deferred tax disclosures in more detail
(Appendix 10C).
These questions are available to assign in myBusinessCourse.
Section 1: Leases, Pensions, and Income Taxes
True/False
Topic: Lease Capitalization
LO: 1
1. Capitalizing leases have little effect on a company’s return on equity (ROE) ratio.
Answer: True
Rationale: ROE is largely unaffected since net income and stockholders’ equity are largely
unaffected. However, capitalizing leases does affect the components of ROE such as FLEV and
, NOAT and RNOA. 8. The defined contribution plan and the defined benefit plan are the two general types of pension plans
offered by companies.
Topic: Leases as a Financing Source Answer: True
LO: 1 Rationale: For defined contribution plans, the company records the expense at the time the liability is
2. Leases can be a better financing vehicle because leases often require less equity investment than accrued. For defined benefit plans, the obligation is not satisfied until paid; companies are only
traditional bank financing. required to report the net pension liability on the balance sheet.
Answer: True
Rationale: Leases generally require less up-front investment than does bank financing. Topic: Service Cost
LO: 2
9. The increase in pension obligation due to an employee working an additional year for the employer
Topic: Financial Statements of Non-Capitalization will cause the net pension liability on the balance sheet to increase.
LO: 1
3. Failure to recognize lease assets and liabilities results in understated financial leverage and Answer: True
understated net operating profit (NOPAT). Rationale: The increase in the pension obligation arises from increases in service and interest costs.
Topic: Income Taxes
Answer: False LO: 3
Rationale: Failure to recognize lease assets and liabilities does understate FLEV because liabilities 10. Income tax expense is not recorded at the amount owing to the tax authorities even if this is the most
are lower in the FLEV numerator. However, failure to recognize lease assets and liabilities usually objectively measured amount.
overstates NOPAT because the entire lease payment is deducted from NOPAT instead of just the
depreciation portion. Answer: True
Rationale: Income tax expense is based on GAAP numbers. The amount paid is based on tax rules.
The difference between the two is recorded as deferred tax expense (benefit).
Topic: Expenses and Cash Flows Relating to Operating Leases
LO: 1
4. Operating leases increase interest expense in the income statement, while decreasing net cash flows Topic: Deferred Taxes
in the cash flow statement, compared with capital leases. LO: 3
11. When a company reports a deferred tax asset it means that the company will receive a tax benefit in
Answer: False the future.
Rationale: Operating leases record rent expense, rather than interest and depreciation. Further, the
lease payments (e.g., cash outflows) are the same, whether or not the lease is capitalized. Answer: False
Topic: Financial Statement Effects of Capital Leases Rationale: The deferred tax asset may be recorded if the future benefit is more likely than not. The
LO: 1 company does not have to be absolutely certain only relatively certain that future taxes will be lower
5. Using the capital lease method requires that both the lease asset and lease liability be reported off (a benefit).
the balance sheet.
Multiple Choice
Answer: False
Rationale: The capital lease method requires that both the lease asset and lease liability be reported
on the balance sheet. The leased asset is depreciated like any other long-term asset. The lease Topic: Reporting of Leases
liability is amortized like a note, with lease payments separated into interest and principal repayment. LO: 1
1. Under the new accounting standard for leases (effective 2019), companies classify all capitalized
leases as either:
Topic: Actual vs. Expected Returns on Pension Investments A) Non-operating or operating leases
LO: 2 B) Finance or operating leases
6. GAAP permits companies to choose to report pension expense based either on actual investment C) Capital or operating leases
returns of pension investments or on expected returns. However, once a company makes the choice, D) Variable interest or fixed rate leases
it cannot switch methods. E) None of the above
Answer: False Answer: B
Rationale: GAAP allows companies to report pension expense income based on the expected return Rationale: Under the new standard, companies classify all capitalized leases as either a finance lease
of the pension investment. The aim is to stabilize long-term returns versus seeing annual or quarterly (where the lease transfers control of the lease asset to a lessee and is effectively like purchasing the
swings due to the fluctuation in the market. asset) or an operating lease (the lessee controls only the use the lease asset, but not the asset itself).
Topic: Reporting of Pension Investments and Liabilities Topic: Reporting of Operating Leases
LO: 2 LO: 1
7. Companies are required to report total pension assets and pension liabilities on their balance sheets. 2. Under the pre-2019 accounting standards, how are operating leases reported in the lessee’s balance
sheet?
Answer: False A) As an asset that is depreciated, similar to the company’s other assets.
Rationale: Companies are required to report only the funded status (that is, the net pension asset or B) As either a short-term or long-term liability, depending on the length of the lease
liability) on their balance sheets. C) At the present value of the future minimum lease payments.
D) Operating leases are not disclosed in the lessee’s balance sheet or annual report.
E) None of the above
Topic: Pension Plans
LO: 2 Answer: E
Rationale: Under the pre-2019 accounting rules, operating leases are not reported on a company’s
, balance sheet. However, operating leases are noted in the footnotes to the financial statements, What economic liability is potentially left off Organic Market’s balance sheet? Round the remaining
which provide key details regarding the company’s current and future lease payment obligations. lease term to the nearest whole year.
Topic: Present Value of Operating Lease Payments (Numerical calculations required) Year
LO: 1, 4 Minimum operating lease payments
3. Bald Industries disclosed the following minimum rental commitments under non-cancelable operating
2017 $ 346
leases in its 2017 annual report:
2018 418
Minimum operating lease payments Amount (in millions) 2019 446
2018 $ 71 2020 454
2019 46
2021 455
2020 34
Thereafter 5,188
2021 26
2022 20 $7,307
Total $197
A) $5,362 million
B) $5,430 million
What is the present value of these operating lease payments, assuming a 6% discount rate? (Round C) $7,307 million
your final answer to the nearest whole dollar) D) $4,454 million
A) $180 million E) None of these are correct.
B) $ 56 million
C) $172 million Answer: D
D) $197 million Rationale: The omitted liability is equal to the present value of the future minimum lease payments –
E) None of these are correct. $4,454 million.
Answer: C
Rationale: The following chart shows the calculation used to determine the present value of operating Discount Factor
leases at Beacon Industries (amounts are in millions): Operating Leases I=6.0% Present Value
2017 $ 346 0.94340 $ 326.42
Minimum operating lease payments
2018 418 0.89000 372.02
Amount
(in millions) 2019 446 0.83962 374.47
Present value factor 2020 454 0.79209 359.61
Present value 2021 455 0.74726 340.00
(in millions) Thereafter 5,188 5.89354* 2,681.56**
2018 $ 71 0.9434 $ 66.98 Total $9,134 $4,454
2019 46 0.89 40.94
Remaining lease life is 11.0 years ($5,188 /$455 = 11.4022)
2020 34 0.83962 28.55 * 0.74726 x 7.88687 = 5.89354
2021 26 0.79209 20.59 ** $455 × 5.89354 = $2,681.56
2022 20 0.74726 14.95 Topic: Present Value of Operating Lease Payments (Numerical calculations required)
Total $197 $172.01 LO: 1, 4
6. Caleb’s Corp disclosed the following minimum rental commitments under non-cancelable operating
leases in its 2020 annual report (in millions).
Topic: Financial Statement Impacts of Capital and Operating Leases
LO: 1 Operating
4. Under the pre-2019 accounting standards, GAAP identifies two different approaches in the reporting Leases
of leases by the lessee: capital and operating. Which of the following best describes the effects of 2021 $19,539
leasing on the financial statements of the lessee? 2022 20,196
Lease Type Assets Liabilities Expenses 2023 20,052
2024 19,746
A) Operating Increased Increased Depreciation and Interest
B) Capital Increased Increased Rent 2025 19,270
C) Operating None None Rent Thereafter 234,134
D) Capital None None Rent Total $332,937
E) Operating None None Depreciation and Interest What is the approximate present value of the minimum lease payments? Assume a discount rate of
6.0% and round the remaining lease term to the nearest whole year using the final lease payment
Answer: C provided as an estimate of annual future payments.
Rationale: Operating leases have no balance sheet effect and incur rent expense on the income
statement, thus options A and E are incorrect. Capital leases increase assets and liabilities and incur A) $244,841 million
depreciation and interest expense, thus B and D are incorrect. B) $248,339 million
Topic: Present Value of Operating Lease Payments (Numerical calculations required) C) $255,007 million
LO: 1, 4 D) $298,937 million
5. Organic Markets reports operating lease information in its 2016 annual report (in millions). You E) $204,009 million
determine that a discount rate of 6.0% is appropriate for Organic Markets and calculate the following.
, Answer: E Net minimum lease payments $12,960 $1,446,240
Rationale: The present value of the future minimum lease payments is $255,007 million. Less amount representing interest 5,800
Discount Factor Present value of lease obligations $7,160
Operating Leases I=6.0% Present Value
2021 $19,539 0.94340 $ 18,433.09 Continued
2022 20,196 0.89000 17,974.44
Compute the approximate present value of Falls Financial Corporation’s operating leases using a
2023 20,052 0.83962 16,836.06 discount rate of 11%.
2024 19,746 0.79209 15,640.61
2025 19,270 0.74726 14,399.70 A) $1,446,240 million
B) $1,302,394 million
Thereafter 234,134 6.26491* 120,724.82
C) $1,232,180 million
Total $332,937 $204,009 D) $1,435,600 million
Remaining lease life is 12.0 years ($234,134/$19,134= 12.15018) E) $1,330,799 million
* 0.74726 x 8.38384 = 6.26491
** $19,270 × 6.26491 = $120,724.82
Topic: Analyzing Lease Footnote Answer: C
Note to Instructor: This question requires that students are able to use the IRR function of a Rationale: Students answer will vary depending on method used for calculation. Using a financial
financial calculator or use of a spreadsheet. calculator or spreadsheet and not rounding answer until total = $1,232,180. Using the tables and
LO: 1, 4 rounding each present value to the nearest whole number = $1,232,180 which is the best available
7. Falls Financial Corp. 2020 annual report discloses the following lease payments: answer for the approximate present value of the operating leases.
Fiscal year Fiscal year
Capital leases Operating Lease
Operating leases Payment
2021 $ 14,256 $2,514,240 Discount Factor
2022 11,664 720,576 (i=0.11) Present Value
2021 $931,200
2023 9,072 527,472
2022 266,880
2024 0 102,384
2023 195,360
2025 0 40,176
2024 37,920
Net minimum lease payments 34,992 $3,904,848
Less amount representing interest 5,800 0.90090 $838,918.08
Present value of lease obligations $29,192 0.81162 216,605.15
0.73119 142,845.28
What is the approximate implicit rate of return on the capital leases? 0.65873 24,979.04
2025 14,880 0.59345 8,830.54
A) 11.4% $1,446,240
Total $1,232,178
B) 10.0%
C) 16.6%
D) 10.5%
Topic: Pension Expense
E) 10.3%
LO: 2
9. What are the four basic components of pension expense?
Answer: D A) Service cost, benefits paid, expected return on plan assets, and amortization of deferred amounts
Rationale: Using a financial calculator to determine the implicit interest rate, the inputs are as follows: B) Service cost, benefits paid, actual return on plan assets, and amortization of deferred amounts
C) Service cost, interest cost, actual return on plan assets, and amortization of deferred amounts
CF0 = -29192; CF1 = 14256; CF2 = 11664; CF3 = 9072; calculate IRR = 10.4700% or 10.5%.
D) Service cost, interest cost, expected return on plan assets, and amortization of deferred amounts
E) None of these are correct.
Topic: Analyzing Lease Footnote
LO: 1, 4 Answer: D
Rationale: Actual returns affect the pension assets but not the expense; benefits paid affect the PBO
8. Falls Financial Corp. 2020 annual report discloses the following lease payments:
and plan assets but not the expense.
Fiscal year
Topic: Actuarial Gains and Losses
Capital leases LO: 2
Operating leases 10. Actuarial gains and losses arise from:
2021 $ 5,280 $931,200 A) Changes in mortality rates
2022 4,320 266,880 B) Changes in discount rate
2023 3,360 195,360 C) Changes in estimates of wage inflation
D) A and C only
2024 0 3714,920
E) All of the above
2025 0 37,880
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