Question

The amount to be recorded as the cost of an asset under a finance lease is equal to the
A. present value of the lease payments or the fair value of the asset, whichever is lower.

B. present value of the lease payments.

C. carrying value of the asset on the lessor's books.

D. present value of the lease payments plus the present value of any unguaranteed residual value.

From the lessee’s perspective, in the earlier years of a lease,
A. operating leases will cause income to increase, compared to finance leases.

B. finance leases will enable the lessee to report higher income, compared to operating leases.

C. finance leases will cause debt to increase, compared to operating leases.

D. operating leases will cause debt to increase, compared to finance leases.

Answer 1

1. The correct answer is A. present value of the lease payments or the fair value of the asset, whichever is lower.

Normally the cost of the asset is recorded at its present or fair value, whichever is less. It is done based on the Conservatism principle of accounting which states that anticipated losses should be accounted for, but the anticipated gains should not be accounted for.

So, the asset value is recorded at the least value of the alternative valuations.

2. The correct answer is C. finance leases will cause debt to increase, compared to operating leases.

In the earlier years of lease, operating lease is more beneficial than finance leases. Finance lease creates huge burden of debt in form of lease payment and interest expense in the earlier years. Hence, under finance lease, the lease amount and interest are higher in earlier years than operating lease.