Chapter 18, Problem 18.4E

Operating Lease, Rate or Index, Effect of Variable Lease Payments, Lessee. Caye Comfort, Inc. manufactures a complete line of beds, cots, and futons. Caye Comfort leases a spring fabricating machine from Stein Spring Company for 3 years with no renewal or purchase options. The equipment has a fair value of $10,000 and title will be retained by the lessor at the end of the lease term. The economic life of the equipment is 6 years. The implicit rate in the lease is 5%.

The lessee pays all maintenance to a third party and there are no initial direct costs. There are no incentives offered by the lessor. The first annual payment is $1,300 (due January 1, Year 1). and the payment increases each year by an amount equal to $1.300 multiplied by the Producers Price Index (PPI) The PPI on the lease commencement date is 1 00 and is forecast to increase by 4% each year The increases in the payments will be at least 4% per year The remaining lease payments are due on December 31, Year 1 and December 31, Year 2.

Required

1. a. Determine the proper classification of the lease for the lessee.
2. b. Prepare the journal entries and supporting amortization tables to account for this agreement for the lessee over the lease term