You are a senior auditor auditing the December 31, 2017 financial statements of Hoang, Inc., a manufacturer of novelties and party favours and a user of ASPE. During your inspection of the company garage, you discovered that a 2016 Shirk automobile is parked in the company garage but is not listed in the equipment subsidiary ledger. You ask the plant manager about the vehicle, and she tells you that the company did not list the automobile because the company is only leasing it. The lease agreement was entered into on January 1, 2017 with Quick Deal New and Used Cars. You decide to review the lease agreement to ensure that the lease should be given operating lease treatment, and you discover the following lease terms.

1. It is a non-cancellable term of 50 months.

2. The rental is $220 per month at the end of each month. (The present value at 1% per month is $8,623.)

3. The estimated residual value after 50 months is $2,100. (The present value at 1% per month is $1,277.) Hoang guarantees the residual value of $2,100.

4. The automobile's estimated economic life is 60 months.

5. Hoang's incremental borrowing rate is 12% per year (1% per month).

Instructions

Write a memo to your supervisor, the audit partner in charge of this audit, to discuss the situation. Be sure to include the following:

Why you inspected the lease agreement,

What you determined about the lease, and

How you advised your client to account for this lease.

Explain every journal entry that you believe is necessary to record this lease properly on the client's bo