Reference no: EM131821817

Question - Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.

1. The lease term is 10 years, non-cancelable, and requires equal rental payments of $30,300 due at the beginning of each year starting January 1, 2012.

2. The equipment has a fair value and cost at the inception of the lease (January 1, 2012) of $220,404, an estimated economic life of 10 years, and a residual value (which is guaranteed by Goring Dairy) of $20,000.

3. The lease contains no renewable options, and the equipment reverts to King Finance Company upon termination of the lease.

4. Goring Dairy's incremental borrowing rate is 9% per year. The implicit rate is also 9%.

5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.

6. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

(a) Evaluate the criteria for classification of the lease, and describe the nature of the lease. In general, discuss how the lessee and lessor should account for the lease transaction.