Alta Corporation entered into an agreement with Snowfire Company to lease equipment for use in its ski manufacturing facility. The lease is appropriately recorded as a purchase by Alta and as a sale by Snowfire. The agreement specifies that lease payments will be made on an annual basis. The cost of the machine is reported as inventory on Snowfire's accounting records. Because of extensive changes in ski manufacturing technology, the machine is not expected to have any residual value. Alta uses straight-line depreciation and computes depreciation to the nearest month. After three years, Alta purchases the machine from Snowfire.
Annual lease payments do not include executory costs. Other terms of the agreement are as follows:
Machine cost recorded in inventory . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . $3,700,000
Price at purchase option date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,250,000
Lease payments (paid in advance) . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . $710,000
Contract interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10%
Contract date/first lease payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oct. 1, 2013
Date of Alta purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oct. 1, 2016
Lease period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 years
Instructions: Prepare journal entries on the books of both the lessee and the lessor as follows:
1. Make entries in 2013 to record the first lease payment, and make adjustments necessary at December 31, the end of each company's fiscal year.
2. Record all entries required in 2014.
3. Prepare the entries in 2016 to record the sale (on Snowfire's books) and purchase (on Alta's books), assuming that no previous entries have been made during the year in connection with the lease.