Cleveland Inc. leased a new crane to Abriendo Construction under a 5-year, noncancelable contract starting January 1, 2020. Terms of the lease require payments of $48,555 each January 1, starting January 1, 2020. The crane has an estimated life of 7 years, a fair value of $240,000, and a cost to Cleveland of $240,000. The estimated fair value of the crane is expected to be $45,000 (unguaranteed) at the end of the lease term. No bargain purchase or renewal options are included in the contract, and it is not a specialized asset. Both Cleveland and Abriendo adjust and close books annually at December 31. Collectibility of the lease payments is probable. Abriendo’s incremental borrowing rate is 8%, and Cleveland’s implicit interest rate of 8% is known to Abriendo.

Instructions

a. Identify the type of lease involved and give reasons for your classification. Discuss the accounting treatment that should be applied by both the lessee and the lessor.

b. Prepare all the entries related to the lease contract and leased asset for the year 2020 for the lessee and lessor, assuming Abriendo uses straight-line amortization for all similar leased assets, and Cleveland depreciates the asset on a straight-line basis with a salvage value of $15,000.

c. Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2020.