Crown leases a limo to Zap Productions for four years on January 1, 1998, requiring equal annual payments on each January I and, in addition, a single lump-sum prepayment of $3,000. The leased asset, recently purchased new, cost the lessor $50,000. The estimated unguaranteed value of the asset at end of lease term is $20,000.
The annual lease payments were computed to yield Crown 12 percent (the implicit interest rate after considering that the residual value is known to Zap Productions). The leased asset has an eight-year life with zero residual value at the end of year 8. There is no bargain purchase option, and the asset is retained by Crown at the end of the lease term. Depreciation will be on the straight-line basis. The accounting period for both lessor and lessee ends December 31.
Required:
1. Compute the annual lease payment.
2. What type of lease is this? Explain.
3. In parallel columns for the lessor and lessee, give:
a. Entries at the inception of the lease, including the initial advance payment.
b. Adjusting and closing entries for the year ended December 31, 1998. Use straight-line amortization for the prepayment.