Reference no: EM132316444

Question

Amsterdam Leasing Company agrees to lease machinery to Harrisburg Corporation on January 1, 2019. The following information relates to the lease agreement. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. The asset is not of a specialized nature.

The machinery cost is $525,000 and the fair value of the asset on January 1, 2019 is $700,000. At the end of the lease term, the asset reverts to lessor and has a guaranteed residual value of $50,000 and Harrisburg estimates the expected residual value at the end of the lease term will be $50,000.

Harrisburg amortizes all of its leased equipment on the straight-line basis. The lease agreement requires equal of $109,365, beginning on January 1, 2019. The lessor believes the collect-ability of the lease payments is probable. Amsterdam desires a rate of return on its investments. Harrisburg's incremental borrowing rate is 6%, and the lessor's incremental implicit rate is unknown.

Instructions:

Using the lease classification tests, determine the nature of this lease for the lessee.

Compute the value of the lease liability to the lessee.

Create the journal entries for Harrisburg for 2019 and 2020 related to the lease arrangements.

Suppose Harrisburg estimates the residual value at the end of the lease term to be $40,000, but still guarantees a residual of $50,000.

Compute the value of the lease liability at lease commencement.

NOTE: Round all numbers to the nearest dollar.