On January 1, 2016, Curran Manufacturing Corporation (CMC) agreed to lease a piece of heavy equipment to Oates Products, Inc. CMC paid $ 900,000 to manufacture the machine and carries it at this amount in its inventory. The fair value (current selling price) of the machine is $ 929,049. The relevant lease terms are listed below.
• Annual rental payments of $ 240,000 are due on December 31 of each year. However, the first payment is due at the lease inception. These are the minimum rental payments and do not include any executory costs.
• Lease term is four years.
• There is no bargain purchase option.
• The lessor expects to recover the guaranteed residual value of $ 60,000 at the termination of the lease.
• The economic life of the asset is seven years.
• The lessor’s 6% implicit rate is known to Oates Products, Inc.
• The lessee’s incremental borrowing rate is 8%.
• Annual maintenance is $ 10,000 and annual property tax is $ 7,700. The lessee pays both at the end of the year and classifies these costs as general and administrative expenses.
• CMC has no material uncertainties regarding future costs to be incurred under the lease and collectability is reasonably assured.
• Oates depreciates (amortizes) similar equipment using the straight- line method.
Required
a. Determine if this is an operating or a capital lease for both the lessor and the lessee.
b. Prepare the amortization table for the entire lease term.
c. Prepare the lessee’s journal entries required for each year of the lease term assuming that the equipment is returned with a fair value of $ 60,000.
d. Prepare the lessor’s journal entries required for each year of the lease term assuming that the equipment is returned with a fair value of $ 60,000.
e. Prepare journal entries for the lessee assuming that the equipment is returned with a fair value of $ 45,000.
f. Prepare journal entries for the lessor assuming that the equipment is returned with a fair value of $ 45,000.