Reference no: EM132933976

Island Creamery, leases its ice cream making equipment from Big Rock Finance Company under the following lease terms:

1. The lease term is five years, non-cancellable, and requires equal rental payments of $56,926 due at the beginning of each year starting January 1, 2019.
2. Upon inception of the lease on January 1, 2019, Big Rock purchased the equipment at its fair value of $280,000 and immediately transferred it to Island Creamery. The equipment has an estimated economic life of five years, and an expected payout under the residual value guarantee is $20,000.
3. The lease contains no renewal options, and the equipment reverts to Big Rock Finance Company upon termination of the lease.
4. Island 's incremental borrowing rate is 5%; the rate implicit in the lease is also 4%. The implicit rate in the lease is not readily determinable by Island.
5. Island depreciates similar equipment that it owns on a straight-line basis.
6. Both companies have December 31 year-ends.

Required:

Problem 1. Evaluate how the lessor should account for the lease transaction.

Problem 2. Prepare the journal entries on January 1, 2019, December 31, 2019, and January 1, 2020 for the lessor.