On January 1, 2021, the Oak Company signs a five-year lease for general excavating equipment, agreeing to pay $60,000 annually at the beginning of each year under the non-cancelable lease. Superior Equipment Company, the lessor, agrees to pay all executory costs, estimated to be $3,650 per year. On the date the lease is signed the fair value of the equipment is $320,000. On December 31, 2020 the equipment had a carrying value on Superior’s balance sheet of $265,000. The equipment’s estimated life is 10 years. The estimated residual value at the end of five years is $75,000 and is not guaranteed by Oak. There is no purchase option in the lease nor any agreement to transfer ownership at the end of the lease to the lessee. Superior set the implicit interest rate as 12% and the rate is known by Oak. On June 30, 2021, Superior Equipment pays property taxes of $850, maintenance costs of $1,800, and insurance of $1,400. Straight-line depreciation is considered the appropriate method by both companies. Superior considers collectability of the lease payments is probable.

Required Identify the type of lease involved for Superior Equipment Company and give reasons for your classifications. Prepare appropriate journal entries for 2021 for both the lessor and lessee. If the residual value at the end of five years was guaranteed by Oak, would your answer to requirement #1 change?

Answer rating: 100% (QA)

An equipment lease agreement is a contractual agreement where the lessor who is the owner of the equipment allows the lessee to use the equipment for a specified period in exchange for periodic paymen... View the full answer