Chapter 18, Problem 18.3P

Classification as Finance, Sales-Type, or Operating Lease, Lessee, Lessor, Journal Entries, Unguaranteed Residual Value.

Florida Energy Restoration, Ltd. (FER) enters into a lease agreement on January 1, 2018. To lease standard power generators from R&R Electric, Inc. The terms of the lease follow

• The term of the lease is 7 years with no renewal option. The seven annual lease payments of $300,000 will be made on January 1 of each year.
• The fair value of the equipment at January 1, 2018, is $1,700,479. The equipment has an economic life of 10 years with no salvage value expected at that time. The cost of the equipment to the lessor, R&R, is $1,500,000.
• FER depreciates similar equipment that it owns on a straight-line basis over the economic life of the property.
• FER’s incremental borrowing rate is 10%, and the lessor's 9% implicit rate on the lease is known to FER.
• There are no nonlease components related to this lease.
• Neither party to the lease pays initial direct costs
• The lessor indicates that the collection of the lease payments are reasonably certain.
• There is no guaranteed residual value in the lease contract, however, the lessor, R&R, expects the asset to be worth $100,000 at the end of the lease term.

Required

1. a. Provide justification for classifying this as a finance lease for the lessee.
2. b. Prepare a partial amortization table for 2018 through 2020 for the lessee using the effective interest rate method of amortization.
3. c. Prepare all of FER’s journal entries for 2018 and 2019.
4. d. Prepare the journal entries required for 2018 and 2019 for FER if this were an operating lease.
5. e. What type of lease is this for the lessor? Justify your answer.