Reference no: EM132596926

Question - On January 1, 2019, Precision Pumps leases nonspecialized pumping equipment to Mega Construction. The equipment is delivered on January 1. The lease term is 4 years with no renewal or purchase options, and title to the leased asset is retained by the lessor at the end of the lease term. The lease requires annual fixed rental payments of $7,000 per year beginning on January 1, 2019, and then December 31 of each year starting on December 31, 2019. The fair value of the equipment is $37,592 and has a carrying amount on Precision's books of $22,000. The equipment has a remaining life of 8 years. The estimated residual value of the equipment is $15,000. The lessee does not guarantee the residual value, but Precision secured an unrelated third party to guarantee $15,000; collection of this guaranteed residual value and lease payments is reasonably certain. The rate implicit in the lease is 6%. There are no prepaid rentals, and neither party to the agreement pays initial direct costs.

1. What is the proper classification of this lease for Precision Pumps?

2. Assuming that Precision Pumps classifies this lease as a direct financing lease, prepare the journal entries for the commencement of the lease and the payment of the first and second lease payments.