Mr. Kay Food Mart Incorporated, as lessee, enters into a lease agreement on July 1, 2016, to lease mobile refrigeration equipment from Pollet Products. The cost of the equipment to Pollet is $ 180,000. The following information is relevant to the lease agreement.
• The term of the non-cancellable lease is five years with no renewal options and there is no transfer of title. Payments of $ 44,880 are due beginning on July 1, 2016.
• The fair value of the equipment at July 1, 2016, is $ 196,898. The equipment has an economic life of five years with no residual value.
• Mr. Kay Food Mart depreciates similar equipment it owns on the straight- line basis over the economic life of the property.
• Mr. Kay Food Mart’s incremental borrowing rate is 8% and the lessor’s implicit rate in the lease is not known to Mr. Kay Food Mart.
• There are no executory costs related to this lease.
• There are no material uncertainties as to future costs and collectability is reasonably assured.
Required
a. Determine the type of lease that Mr. Kay Food Mart, the lessee, should record on its books.
b. Prepare all journal entries necessary on the books of Mr. Kay Food Mart for 2016 and 2017. Mr. Kay’s year-end is December 31.
c. How should Pollet Products classify this lease contract? Assume the lessor’s implicit rate is 8%.