Module 10
Reporting and Analyzing
Off-Balance-Sheet Financing
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Describe and illustrate
the accounting for capitalized 1-6, 14 1-10 1-8 1-4 1, 2, 6, 8
leases.
LO2 – Describe and illustrate
7-10, 14 11-21 9-16 5-8 3-6, 8
the accounting for pensions.
LO3 – Explain the accounting
for special purpose entities 11-14 22-23 17-18 9 7, 8
(SPEs).
©Cambridge Business Publishers, 2015
Test Bank, Module 10 10-1
,Module 10: Reporting and Analyzing Off-Balance-Sheet Financing
True/False
Topic: Operating Leases
LO: 1
1. Operating leases appear as liabilities on the lessee’s balance sheet.
Answer: False
Rationale: Operating leases do not appear on the lessee’s balance sheet. An operating lease is
considered a form of off-balance sheet financing for the lessee. The company merely footnotes their
existence and key details in the annual report. Lease payments are reported as rent expense on the
lessee’s income statement.
Topic: Lease Capitalization
LO: 1
2. 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.
Topic: Leases as a Financing Source
LO: 1
3. Leases can be a better financing vehicle because leases often require less equity investment than
traditional bank financing.
Answer: True
Rationale: Leases generally require less up-front investment than does bank financing.
Topic: Financial Statements of Non-Capitalization
LO: 1
4. Failure to recognize lease assets and liabilities results in understated financial leverage and
understated net operating profit (NOPAT).
Answer: False
Rationale: Failure to recognize lease assets and liabilities does understate FLEV because liabilities
are lower in the FLEV numerator. However, failure to recognize lease assets and liabilities usually
overstates NOPAT because the entire lease payment is deducted from NOPAT instead of just the
depreciation portion.
©Cambridge Business Publishers, 2015
10-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Expenses and Cash Flows Relating to Operating Leases
LO: 1
5. Operating leases increase interest expense in the income statement, while decreasing net cash flows
in the cash flow statement, compared with capital leases.
Answer: False
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.
Topic: Financial Statement Effects of Capital Leases
LO: 1
6. Using the capital lease method requires that both the lease asset and lease liability be reported off
the balance sheet.
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
liability is amortized like a note, with lease payments separated into interest and principal repayment.
Topic: Actual vs. Expected Returns on Pension Investments
LO: 2
7. GAAP permits companies to choose to report pension expense based either on actual investment
returns of pension investments or on expected returns. However, once a company makes the choice,
it cannot switch methods.
Answer: False
Rationale: GAAP allows companies to report pension expense income based on the expected return
of the pension investment. The aim is to stabilize long-term returns versus seeing annual or quarterly
swings due to the fluctuation in the market.
Topic: Reporting of Pension Investments and Liabilities
LO: 2
8. Companies are required to report total pension assets and pension liabilities on their balance sheets.
Answer: False
Rationale: Companies are required to report only the funded status (that is, the net pension asset or
liability) on their balance sheets.
Topic: Pension Plans
LO: 2
9. The defined contribution plan and the defined benefit plan are the two general types of pension plans
offered by companies.
Answer: True
Rationale: For defined contribution plans, the company records the expense at the time the liability is
accrued. For defined benefit plans, the obligation is not satisfied until paid; companies are only
required to report the net pension liability on the balance sheet.
©Cambridge Business Publishers, 2015
Test Bank, Module 10 10-3
, Topic: Service Cost
LO: 2
10. The increase in pension obligation due to an employee working an additional year for the employer
will cause the net pension liability on the balance sheet to increase.
Answer: True
Rationale: The increase in the pension obligation arises from increases in service and interest costs.
Topic: Financing Using SPEs
LO: 3
11. Financially savvy companies use SPEs as a last source of financing, due to the significantly higher
cost associated with SPEs compared to traditional debt instruments.
Answer: False
Rationale: SPEs can provide a lower cost financing alternative than borrowing from the traditional
debt markets. This is because the activities of the SPEs are limited, and the cash flows are well
secured. The risk to the lender is, therefore, reduced. Reduced risk requires less of a risk premium
than if the parent company borrows directly from the debt market.
Topic: Consolidation of SPEs
LO: 3
12. Under both U.S. GAAP and IFRS, SPE’s are consolidated based on the transfer of risks and rewards.
Answer: True
Rationale: However, unlike GAAP’s more rules-based orientation, IFRS requires a more conceptual
analysis of risks and rewards, leading to consolidation of more SPEs under IFRS as compared to
GAAP.
Topic: Off-Balance-Sheet Financing
LO: 3
13. Off-balance-sheet financing is not reported on the financial statements or the footnotes to those
statements.
Answer: False
Rationale: Although not reported on the face of the financial statements, GAAP requires detailed
footnote disclosures for off-balance-sheet financing.
Topic: Off-Balance-Sheet Financing
LO: 1, 2, & 3
14. Off-balance-sheet financing is the financing of investing activities where both the financing and
investing accounts are not reported in the financial reports.
Answer: False
Rationale: The off-balance-sheet financing means that the assets and the liabilities are both not
reported on the balance sheet. However, these are reported in the footnotes to the financial
statements.
©Cambridge Business Publishers, 2015
10-4 Financial & Managerial Accounting for MBAs, 4th Edition
Reporting and Analyzing
Off-Balance-Sheet Financing
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Describe and illustrate
the accounting for capitalized 1-6, 14 1-10 1-8 1-4 1, 2, 6, 8
leases.
LO2 – Describe and illustrate
7-10, 14 11-21 9-16 5-8 3-6, 8
the accounting for pensions.
LO3 – Explain the accounting
for special purpose entities 11-14 22-23 17-18 9 7, 8
(SPEs).
©Cambridge Business Publishers, 2015
Test Bank, Module 10 10-1
,Module 10: Reporting and Analyzing Off-Balance-Sheet Financing
True/False
Topic: Operating Leases
LO: 1
1. Operating leases appear as liabilities on the lessee’s balance sheet.
Answer: False
Rationale: Operating leases do not appear on the lessee’s balance sheet. An operating lease is
considered a form of off-balance sheet financing for the lessee. The company merely footnotes their
existence and key details in the annual report. Lease payments are reported as rent expense on the
lessee’s income statement.
Topic: Lease Capitalization
LO: 1
2. 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.
Topic: Leases as a Financing Source
LO: 1
3. Leases can be a better financing vehicle because leases often require less equity investment than
traditional bank financing.
Answer: True
Rationale: Leases generally require less up-front investment than does bank financing.
Topic: Financial Statements of Non-Capitalization
LO: 1
4. Failure to recognize lease assets and liabilities results in understated financial leverage and
understated net operating profit (NOPAT).
Answer: False
Rationale: Failure to recognize lease assets and liabilities does understate FLEV because liabilities
are lower in the FLEV numerator. However, failure to recognize lease assets and liabilities usually
overstates NOPAT because the entire lease payment is deducted from NOPAT instead of just the
depreciation portion.
©Cambridge Business Publishers, 2015
10-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Expenses and Cash Flows Relating to Operating Leases
LO: 1
5. Operating leases increase interest expense in the income statement, while decreasing net cash flows
in the cash flow statement, compared with capital leases.
Answer: False
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.
Topic: Financial Statement Effects of Capital Leases
LO: 1
6. Using the capital lease method requires that both the lease asset and lease liability be reported off
the balance sheet.
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
liability is amortized like a note, with lease payments separated into interest and principal repayment.
Topic: Actual vs. Expected Returns on Pension Investments
LO: 2
7. GAAP permits companies to choose to report pension expense based either on actual investment
returns of pension investments or on expected returns. However, once a company makes the choice,
it cannot switch methods.
Answer: False
Rationale: GAAP allows companies to report pension expense income based on the expected return
of the pension investment. The aim is to stabilize long-term returns versus seeing annual or quarterly
swings due to the fluctuation in the market.
Topic: Reporting of Pension Investments and Liabilities
LO: 2
8. Companies are required to report total pension assets and pension liabilities on their balance sheets.
Answer: False
Rationale: Companies are required to report only the funded status (that is, the net pension asset or
liability) on their balance sheets.
Topic: Pension Plans
LO: 2
9. The defined contribution plan and the defined benefit plan are the two general types of pension plans
offered by companies.
Answer: True
Rationale: For defined contribution plans, the company records the expense at the time the liability is
accrued. For defined benefit plans, the obligation is not satisfied until paid; companies are only
required to report the net pension liability on the balance sheet.
©Cambridge Business Publishers, 2015
Test Bank, Module 10 10-3
, Topic: Service Cost
LO: 2
10. The increase in pension obligation due to an employee working an additional year for the employer
will cause the net pension liability on the balance sheet to increase.
Answer: True
Rationale: The increase in the pension obligation arises from increases in service and interest costs.
Topic: Financing Using SPEs
LO: 3
11. Financially savvy companies use SPEs as a last source of financing, due to the significantly higher
cost associated with SPEs compared to traditional debt instruments.
Answer: False
Rationale: SPEs can provide a lower cost financing alternative than borrowing from the traditional
debt markets. This is because the activities of the SPEs are limited, and the cash flows are well
secured. The risk to the lender is, therefore, reduced. Reduced risk requires less of a risk premium
than if the parent company borrows directly from the debt market.
Topic: Consolidation of SPEs
LO: 3
12. Under both U.S. GAAP and IFRS, SPE’s are consolidated based on the transfer of risks and rewards.
Answer: True
Rationale: However, unlike GAAP’s more rules-based orientation, IFRS requires a more conceptual
analysis of risks and rewards, leading to consolidation of more SPEs under IFRS as compared to
GAAP.
Topic: Off-Balance-Sheet Financing
LO: 3
13. Off-balance-sheet financing is not reported on the financial statements or the footnotes to those
statements.
Answer: False
Rationale: Although not reported on the face of the financial statements, GAAP requires detailed
footnote disclosures for off-balance-sheet financing.
Topic: Off-Balance-Sheet Financing
LO: 1, 2, & 3
14. Off-balance-sheet financing is the financing of investing activities where both the financing and
investing accounts are not reported in the financial reports.
Answer: False
Rationale: The off-balance-sheet financing means that the assets and the liabilities are both not
reported on the balance sheet. However, these are reported in the footnotes to the financial
statements.
©Cambridge Business Publishers, 2015
10-4 Financial & Managerial Accounting for MBAs, 4th Edition
