LePage Manufacturing Ltd. agrees to lease machinery to Labont Corporation on July 15, 2011. Both LePage and

Question:

LePage Manufacturing Ltd. agrees to lease machinery to Labonté on July 15, 2011. Both LePage and Labonté use private enterprise GAAP. The following information relates to the lease agreement.
1. The lease term is seven years, with no renewal option, and the machinery has an estimated economic life of nine years.
2. The machinery’s cost is $420,000 and the asset’s fair value on July 15, 2011, is $560,000.
3. At the end of the lease term, the asset reverts to LePage, the lessor. The asset is expected to have a residual value of $80,000 at this time, and this value is guaranteed by Labonté. Labonté depreciates all of its equipment on a straight-line basis.
4. The lease agreement requires equal annual rental payments, beginning on July 15, 2011.
5. LePage usually sells its equipment to customers who buy the product outright, but Labonté was unable to get acceptable financing for an outright purchase. LePage’s credit investigation on Labonté revealed that the company’s financial situation was deteriorating. Because Labonté had been a good customer many years ago, LePage agreed to enter into this lease agreement, but used a higher than usual 15% interest rate in setting the lease payments. Labonté is aware of this rate.
6. LePage is uncertain about what additional costs it might have to incur in connection with this lease during the lease term, although Labonté has agreed to pay all executory costs directly to third parties.
7. LePage incurred legal costs of $4,000 in early July 2011 in finalizing the lease agreement.
Instructions
(a) Discuss the nature of this lease for both the lessee and the lessor.
(b) Using time value of money tables, a financial calculator, or computer spreadsheet functions, calculate the amount of the annual rental payment that is required.
(c) Prepare the journal entries that Labonté would make in 2011 and 2012 related to the lease arrangement, assuming that the company has a December 31 fiscal year end and that it does not use reversing entries.
(d) From the information you have calculated and recorded, identify all balances related to this lease that would be reported on Labonté’s December 31, 2011 and income statement, and where each amount would be reported.
(e) Prepare the journal entries that LePage would make in 2011 and 2012 related to the lease arrangement, assuming that the company has a December 31 fiscal year end and does not use reversing entries.
(f) From the information you have calculated and recorded, identify all balances related to this lease that would be reported on LePage’s December 31, 2011 and income statement, and where each amount would be reported.
(g) Comment briefly on the December 31, 2011 reported results in (d) and (f) above. Balance Sheet
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