Chapter 18, Problem 18.2P

Classification as Finance or Operating Lease, Lessor, Journal Entries, Discount Rates, Sales-Type Lease, Nonlease Components, Guaranteed Residual Value. On January 1, 2018, the lease commencement date, Curran Manufacturing Corporation (CMC) agreed to lease a piece of nonspeciatized, heavy equipment to Oates Products, Inc CMC paid $900,000 to manufacture the machine and carries it at this amount in its inventory. The fair value (current selling price) of the machine is $929,049 The relevant lease terms follow

• Annual rental payments of $240,000 are due on December 31 of each year. However, the first payment is due at the commencement of the lease. The lease payments do not include any other lease components such as insurance or sales taxes.
• Lease term is 4 years.
• There is no purchase option.
• The lessee guarantees a residual value of $60,000 at the termination of the lease. This amount is equal to the expected residual value and there is no unguaranteed residual asset.
• The economic life of the asset is 7 years.
• The lessor’s 6% implicit rate is known to Oates Products. Inc.
• The lessee’s incremental borrowing rate is 8%.
• Annual maintenance is $10,000 and annual training is $7,700 The lessee pays both at the end of the year to an independent third-party vendor. The lessee classifies these costs as general and administrative expenses.
• CMC indicates that collectability of all lease payments is reasonably assured, and it is probable that the residual value will be fully recovered.
• Oates depreciates (amortizes) similar equipment using the straight-line method.

Required

1. a. Determine whether this is an operating or a finance lease for the lessee and an operating, sales-type, or direct financing lease for the lessor.
2. b. Prepare the amortization table for the entire lease term.
3. c. Prepare the lessee’s journal entries required for each year of the lease term assuming that the equipment is returned with a fair value of $60,000.
4. d. Prepare the lessor’s journal entries required for each year of the lease term assuming that the equipment is returned with a fair value of $60,000.
5. e. Prepare the December 31, 2021, journal entry for the lessee assuming that the equipment is returned with a fair value of $45,000.
6. f. Prepare the December 31, 2021, journal entry for the lessor assuming that the equipment is returned with a fair value of $45,000.