On January 1, 2014, Merchant Co. sold a tractor to Swanson Inc. and simultaneously leased it back for five years. The tractor’s fair value is $250,000, but its carrying value on Merchant’s books prior to the transaction was $200,000. The tractor has a six-year remaining estimated useful life, and Merchant and Swanson both used 8% interest in evaluating the transaction. Merchant has agreed to make five payments of $57,976 beginning January 1, 2014.
1. What type of a lease is this for Merchant and why?
2. Compute the amount of Merchant’s gain on the transaction and explain how Merchant will account for it.
3. Prepare the January 1, 2014, entries on Merchant’s books to account for the sale and leaseback.
4. Assume that the tractor’s carrying value on Merchant’s books was $260,000. Explain how Merchant would account for the loss.