Chapter 16, Problem 20P

Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make lease payments over the next 5 years. The lease is noncancelable and requires equal annual payments of $20,000 per year beginning on January 1 of the first year. The last payment will be January 1 of year 5, and Krawczek will continue to use the asset until December 31 of that year. Other important information includes the following:

The fair value of the equipment is $ 140,000.

The applicable discount rate is an 8 percent annual rate.

The economic life of the asset is 10 years.

Krawczek does not guarantee the residual value of the asset at the end of the lease, and it does not expect to keep the asset at the end of the term.

The asset is a standard piece of equipment.

a. Is the lease an operating lease or a finance lease?

b. What will be the lease expense shown on the income statement at the end of year 1?

c. What will be the interest expense shown on the income statement at the end of year 1?

d. What will be the amortization expense shown on the income statement at the end of year 1?