On January 1, 2018, Lessor Able leased a machine to Lessee Baker on a six-year lease. The machine was purchased by Able immediately prior to the lease; the machine cost Able $400,000. The cash selling price of this machine is $400,000. The machine has a seven-year estimated useful life. The asset goes back to the lessor at the end of the lease term. The lessee guarantees that the residual value will be at least $30,000 when the asset is returned to the lessor at the end of year 6 and the lessee believes that the asset will be worth $20,000 at the end of the lease term. The lessor used a 4% percent target rate of return. The accounting period for each com¬pany ends on December 31 and lease payments will be made beginning on January 1, 2018 and each year thereafter. Collectability of the lease payments is not an issue. Assume a marginal tax rate of 20%.

REQUIRED:

1. Is this an operating or finance lease? Why? (Hint: you should determine this is a finance lease)

2. Calculate the lease payments.

3. Prepare the journal entries for the lessee & lessor for the first two years including any deferred tax entries. Assume the leased asset is returned to the lessor at the end of the lease term and is worth $75,000.

4. Prepare the balance sheet and income statement for the lessee & lessor as of December 31 for 2018.

5. Prepare the SCF for the lessee and lessor for the year ended 12/31/18 and 12/31/19 (using the indirect method for CF from Operating Activities).

6. Prepare the SCF for the lessee and lessor for the year ended 12/31/18 and 12/31/19 (using the direct method for CF from Operating Activities).

Answer rating: 100% (QA)

1 Is this an operating or finance lease Why Hint you should determine this is a finance lease This is a finance lease This is because the lessor has assumed the risks and rewards that are typically as... View the full answer