Reference no: EM132740573
Question - Lessor and Lessee sign a lease agreement dated January 1, 2020 (which is the first day of the fiscal year), that calls for Lessor to lease an equipment to Lessee beginning January 1, 2020. The terms and provisions of the lease agreement, and other pertinent data, are as follows.
- The term of the lease is 3 years. The lease agreement is non-cancellable, requiring equal rental payments of $60,000 at the beginning of each year (annuity-due basis).
- The equipment has a fair value at the commencement of the lease of $180,000, an estimated economic life of 4 years, and a guaranteed residual value of $9,000.
- The lease contains no renewal options. The equipment returns to Lessor at the termination of the lease.
- Lessee's incremental borrowing rate is 6 percent per year.
- Lessee depreciates, on a straight-line basis, similar equipment that it owns.
- Lessor sets the annual rental rate to earn a rate of return of 5 percent per year; Lessee is aware of this rate.
Required -
a. Show your 5 tests of lease classification to determine whether this lease qualifies as a finance lease.
b. Lessee expects that it is probable that the expected value of the residual value at the end of the lease will be greater than the guaranteed amount of $9,000. Prepare the necessary journal entries on 1/1/2020, 12/31/2020, and 1/1/2021 on Lessee's side.
c. Lessee expects that it is probable that the expected value of the residual value at the end of the lease will be $5,000 instead of $9,000, and therefore includes $4,000 as an additional lease payment at the end of the lease. Prepare the necessary journal entries on 1/1/2020, 12/31/2020, and end of the lease on Lessee's side.
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