Reference no: EM132953367

Problem - Krause Company on January 1, 2017, enters into a five-year noncancelable lease, with four renewal options of one year each, for equipment having an estimated useful life of 10 years and a fair value to the lessor, Daly Corp., at the inception of the lease of $3,000,000. Krause's incremental borrowing rate is 8%. Krause uses the straight-line method to depreciate its assets. The lease contains the following provisions:

1. Rental payments of $219,000 including $19,000 for property taxes, payable at the beginning of each period.

2. A termination penalty assuring renewal of the lease for a period of four years after expiration of the initial lease term.

3. An option allowing the lessor to extend the lease one year beyond the last renewal exercised by the lessee.

4. A guarantee by Krause Company that Daly Corp. will realize $100,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $60,000.

Instructions -

(a) What kind of lease is this to Krause Company?

(b) What should be considered the lease term?

(c) What are the minimum lease payments?

(d) What is the present value of the minimum lease payments?

(e) What journal entries would Krause record during the first 3 years of the lease?