Reference no: EM132914436

Question - Epps Corp., a public company, leased equipment from Anderson Inc. on January 2, 2020, for a period of three years. Lease payments of $100,000 are due to Anderson Inc. each year on December 31. The lease contains no purchase or renewal options and the equipment reverts back to Anderson Inc. on the expiration of the lease. The remaining useful life of the equipment is four years (the equipment is new at the time Epps leases it). The fair value of the equipment at lease inception is $300,000. Epps Corp. has guaranteed $20,000 as the residual value at the end of the lease term. The $20,000 represents the expected value of the leased equipment to the lessee at the end of the lease term. The salvage value of the equipment is expected to be $2,000 after the end of its economic life. Epps' incremental borrowing rate is 5 percent. Anderson's implicit rate is 6 percent and is known by Epps.

The assistant controller and controller of Epps Corp. analyzed the lease and made their recommendations for the appropriate accounting.. As the CFO, you were given both analyses to determine the correct accounting treatment. Calculations and journal entries performed by the assistant controller and controller are below.

Assistant controller analysis: Epps should record an asset or liability of $267,301 at the inception of the lease. The amount is determined by taking the present value of the annual lease payment at 6% since the lessor's rate is known. Epps should report lease expense of $100,000 each year for the three years since this is the amount of the lease payment

Controller analysis: Epps should record an asset or liability of $289,602 at the inception of the lease. The amount is determined by taking the present value of both the annual lease payment and the residual value at 5%. The residual value is included because it is guaranteed and 5% is the appropriate interest rate because it the lower of the two rates. Epps' should report interest expense of $14,480 and amortization expense of $96,534 in 2020 on this lease. The interest expense is the lease liability times 5% and the amortization expense is the asset divided by the three year term of the lease. The interest expense will decrease in 2021 while the amortization will remain constant.

Required -

1. Was the assistant controller's analysis correct? Why or why not?

2. Was the controller's analysis correct? Why or why not?

3. If neither answer is correct, explain the appropriate accounting for the lease including all entry(ies) for 2020.

Be sure to provide appropriate authoritative sources for positions taken.