On January 1, 2019, Tobey Company (seller-lessee) sold excavating equipment to Eli Bank (buyer-lessor) for its fair market value of $6,400,000 and immediately leased it back under a fiveyear non-cancellable lease at $1,023,021 per year, first payable on the commencement date. The remaining useful life of the equipment is 20 years, at which time its residual value is expected to be $0. Tobey has provided a residual guarantee for $4,000,000, although the expected payout under this guarantee is only $500,000. Tobey Company must return the asset to Eli at the end of the lease term. Eli used an implicit rate of 12% to determine the lease payments and this is readily determinable by Tobey. The equipment had a carrying value of $4,000,000 on Tobey’s books. Both companies have a December 31 year end and both companies depreciate this type of asset on a straight-line basis.

Required: 

a. Evaluate how Tobey, the seller-lessee, should account for the lease transaction. 

b. Determine the value of the ROU asset and lease liability at initial recognition for Tobey, the seller-lessee. 

c. Prepare the journal entries on January 1, 2019, December 31, 2019, and January 1, 2020, for Tobey, the seller-lessee.