Question: On January 1 2016 Alice Company leases equipment for 5

On January 1, 2016, Alice Company leases equipment for 5 years, agreeing to pay $70,000 annually (including executory costs) at the beginning of each year under the noncancelable lease. Superior Equipment Company, the lessor, agrees to remit all executory costs, estimated to be $3,450 per year. The cost and also fair value of the equipment is $305,000. Its estimated life is 10 years. The estimated residual value at the end of 5 years is $64,000 and is not guaranteed by Alice; at the end of 10 years, it is $5,000. There is no bargain purchase option in the lease or any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. During 2016, Superior Equipment pays property taxes of $650, maintenance costs of $1,600, and insurance of $1,200. There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor. Straight-line depreciation is considered the appropriate method by both companies.
1. Identify the type of lease involved for Alice and Superior Equipment and give reasons for your classifications.
2. Prepare appropriate journal entries for 2016 for the lessee and lessor.
3. If the residual value at the end of 5 years is guaranteed by Alice, identify the type of lease and briefly explain why. Prepare journal entries for 2016 and 2017 for the lessee and lessor. Also prepare the journal entries for the lessee and the lessor when the lessee pays the guaranteed residual value.

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  • CreatedOctober 05, 2015
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