Assume the following facts concerning a sales-type lease:
• The lease term is three years and qualifies as a capital lease for both lessor and lessee. The asset reverts to the lessor at the end of the lease term. Assume straight-line depreciation by the lessee.
• Payments are $50,000 at the beginning of each year, plus a guaranteed residual value of $10,000 at the end of the lease term. The lessor estimates a total residual value of $15,000. Lease payments include $4,000 for executory costs under a maintenance agreement.
• Initial direct costs associated with the lease are $2,700.
• Cash sales price of the asset is $137,102.50. Lessor’s manufacturing cost is $100,000.
• The lessee does not know the lessor’s implicit rate, but its own incremental borrowing rate is 11 percent.
Required:
a. Prepare the accounting entries for both lessor and lessee for the three years. What happens in Year 3 if residual value is only $8,000?
b. Assume the same facts as before except that the asset is first sold to a finance company, which then leases the asset to the lessee. Prepare the required entries in all three years for lessor and lessee.
c. Evaluate the differences between requirements (a) and (b) as well as the differences between lessor and lessee.