Preparing lessor’s journal entries for an operating lease and a capital lease. Sun Microsystems manufacturers an engineering workstation for $7,200 and sells it for $12,000. Although the workstation has a physical life of approximately ten years, rapid technological change limits its expected useful life to three years. Sun leases a workstation to Design Consultants for the three-year period beginning January 1, 2008. The annual rental payments of $4,386.70 are due at the beginning of each year. The interest rate appropriate for discounting cash flows is 10%, compounded annually. Sun uses a calendar year as its reporting period.

a. Does this lease qualify as an operating lease or a capital lease? Explain.

b. Assume that this lease qualifies as an operating lease. Give the journal entries for Sun Microsystems over the three-year period.

c. Repeat part b assuming that the lease qualifies as a capital lease.