Trost Leasing Company buys equipment for leasing to various manufacturing companies. On October 1, 2010, Trost leases a press to Shumway Shoe Company. The cost of the machine to Trost was $196,110, which approximated its fair value on the lease date. The lease payments stipulated in the lease are $33,000 per year in advance for the 10-year period of the lease. The payments include executory costs of $3,000 per year. The expected economic life of the equipment is also 10 years. The title to the equipment remains in the hands of Trost Leasing Company at the end of the lease term, although only nominal residual value is expected at that time. Shumway’s incremental borrowing rate is 10%, and it uses the straight-line method of depreciation on all owned equipment. Both Shumway and Trost have fiscal years ending September 30, and lease payments are made on this date.

Instructions:

1. Prepare the entries to record the lease and the first lease payment on the books of the lessor and lessee, assuming the lease meets the criteria of a direct financing lease for the lessor and a capital lease for the lessee.

2. Compute the implicit rate of interest of the lessor.

3. Give all entries required to account for the lease on both the lessee’s and lessor’s books for the fiscal years 2011, 2012, and 2013.