On January 1, 2017, Fargo Corp. enters into a ten-year

On January 1, 2017, Fargo Corp. enters into a ten-year non-cancellable lease with Wells Ltd. for equipment having an estimated useful life of 11 years and a fair value of $6,000,000. Fargo's incremental borrowing rate is 8%, but they do not know Wells’ implicit rate. Fargo uses the straight-line method to depreciate assets. The lease contains the following provisions:

1.Semi-annual lease payments of $438,000 (including $38,000 for property taxes), payable on January 1 and July 1 of each year.

2.A guarantee by Fargo Corp. that Wells Ltd. will realize $200,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $120,000.

Both companies adhere to ASPE.

Instructions

a) Calculate the undiscounted minimum lease payments over the life of the lease.

b) Calculate the present value of the minimum lease payments. PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for $1 due in 20 interest periods at 8% annual rate, .45639. Round to nearest dollar.

c) What kind of lease is this to Fargo Corp.? Why?

d) Present the journal entries that Fargo would record during the first year of the lease. Include an amortization schedule through January 1, 2018and round values to the nearest dollar.


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