Spring 2011 – Exam 1 – Study Guide for Acct 414
What you need to understand about leases (a little less than half of the exam points):
1. You need to know the BASIC rules (first page of MSWord file that had the journal entry
examples and/or those 2 flow charts from ppt slides) on how to classify leases. There
won't be any nonrenewal penalties, guarantees of lessor's debt by lessee, or other
complications like real estate or used property – those are research questions and not
things anyone sets out to memorize.
2. You need to know the five indicators under IFRS and be able to explain why the
classification might be different than it is under US GAAP. For example, you need to be
aware of the fact that the interest rate choice for the lessee is different than US GAAP
and that there are no “extra rules” for classifying a lease for lessor. We practiced this on
Project 1 and 2.
3. I expect you to be able to find the PVMLP for general situations (e.g., title transfer,
bargain purchase options, etc.). This means knowing what to include (or exclude) in the
minimum lease payments and which discount rate to use.
 An unguaranteed residual value is NEVER part of the minimum lease payments
(lessor or lessee) but a guaranteed residual value is included (in both lessor and
lessee MLP if guaranteed BY the lessee and just in lessor's MLP if guaranteed by
a 3rd party).
 The lessee uses the lower of incremental borrowing rate or the lessor’s implicit
rate, if the implicit rate is known (US GAAP).
 The lessor always uses the implicit rate.
 Under IFRS, the lessee uses the implicit rate unless it is not practical to figure it
out, in which case lessee uses incremental borrowing rate.
 If there is a direct financing lease with initial direct costs, you may need to find a
revised implicit rate (different from the one the lessor used to calculate the lease
payments).
4. You need to be able to prepare at least the first two rows of a lease amortization table.
 The lessee’s amortization table starts with PVMLP (unless it is greater than FMV,
in which case start with FMV and find the implicit rate).
 The lessor's amortization table starts with fair market value of the asset if it is a
sales type lease
 The lessor's amortization table starts with fair market value of the asset PLUS
initial direct costs if it is a direct financing lease {this is when you have to find a
revised implicit rate}.
5. You need to be able to make journal entries for both the lessee and the lessor (similar to
Project 1). I could ask for journal entries under US GAAP or IFRS which essentially the
same except the lease might be classified differently.
 For the lessee, you need to be able to make the journal entries for either an
operating or a capital lease and you need to know what useful life over which to
amortize the leased asset (useful life if title transfer or BPO, otherwise lease term)
 You need to know how to do the lessor journal entries when there is an initial
direct cost (different for each type of lease)

You need to be able to do the lessor journal entries for a sales type lease or a
direct financing lease (with or without an unguaranteed residual value ) as well as
an operating lease.
6. You should know definitions of initial direct costs and executory costs and know what to
do with them for each type of lease.
 IDC affects lessor only but treatment depend on type of lease
 Executory costs are subtracted from lease payment but ONLY when paid by the
lessor. That would mean the cost are included in the lease payment. {In other
words, the lessee is “supposed to” pay executory costs as separate expenses in
addition to any lease payment.}
7. Other time-value of money computations related to leases:
 How to find the interest rate implicit in a lease. {Remember that there may be a
residual value that the lessor must consider in determining the rate even though
we always exclude unguaranteed residual values from the PVMLP test.}
 How to find the payment to give the lessor a desired rate of return. The fair value
of the asset is entered as the negative PV and any RV or BPO at lease end is
entered as a positive number on calculator or in Excel.
Other topics (the other half of available points):
 You should know how to record a serial bond including year-end interest accruals using the effective interest method and the bonds outstanding method (I might give you a
choice but I might ask for one or the other or both.) The bonds will be semi-annual just
like the homework.
 There will be at least one problem on troubled debt restructuring which will require
selected journal entries for creditor (but not for the debtor). You need to know how to
find the present value of the cash flows to determine the restructured receivable for the
creditor – always use the original interest rate.
 I'll throw in a few present value problems similar to first homework assignment but
some of them will be related to leases and/or troubled debt situations.
 In all problems, you need to "think like an accountant" and be aware of the need to do
year-end accruals of interest, depreciation, etc.
 Fair value option problem will be similar to the ones you did for homework. I’ll ask for
balance sheets one year later so you have to consider interest revenue and interest
expense. These will be semi-annual bonds.
Practicing on old exams is very helpful – just remember that this exam will NOT cover debtor
accounting in troubled debt situations and long-term construction contracts. It does have
relatively new content – primarily leases under IFRS and fair value option. We also covered the
fair value option and loan impairments under IFRS but the accounting was essentially the same
so I don’t have questions on how those topics differ from US GAAP.