Florida Energy Restoration, Ltd. (FER) enters into a lease agreement on January 1, 2016, to lease power generators from R& R Electric, Inc. The terms of the lease are presented below:
• The term of the non-cancellable lease is seven years with no renewal option. The seven annual lease payments of $ 300,000 are made at the beginning of each year.
• The fair value of the equipment at January 1, 2016, 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 it owns on the 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 executory costs related to this lease.
• There are no material uncertainties as to collection of the lease payments and no future costs to be incurred under the lease.
• 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
a. Provide justification that this is a capital lease for the lessee.
b. Prepare a partial amortization table for 2016 through 2018 using the effective interest rate method of amortization.
c. Prepare all of FER’s journal entries for 2016 and 2017.
d. Prepare the journal entries required for 2016 and 2017 for FER if this was an operating lease.
e. What type of lease is this for the lessor? Justify your answer.