Anthony Incorporated leases a piece of machinery to Irving Company on January 1, 2020, under the following terms.

1. The lease is to be for 4 years with rental payments of $12,471 to be made at the beginning of each year.

2. The machinery’ has a fair value of $67,000, a book value of $50,000, and an economic life of 10 years.

3. At the end of the lease term, both parties expect the machinery to have a residual value of $25,000. To protect against a large loss, Anthony requests Irving to guarantee $17,500 of the residual value, which Irving agrees to do.

4. The lease does not transfer ownership at the end of the lease term, does not have any bargain purchase options, and the asset is not of a specialized nature.

5. The implicit rate is 5%, which is known by Irving.

6. Collectibility of the payments is probable.

Instructions

a. Evaluate the criteria for classification of the lease, and describe the nature of the lease.

b. Prepare the journal entries for Irving for the year 2020.

c. Prepare the journal entries for Anthony for the year 2020.

d. Suppose Irving did not guarantee any amount of the expected residual value. How would your answers to parts a–c change?