Mullen Equipment Company both leases and sells its equipment to its customers. The most popular line of equipment includes a machine that costs $280,000 to manufacture. The standard lease terms provide for five annual payments of $110,000 each (excluding executory costs), with the first payment due when the lease is signed and subsequent payments due on December 31 of each year. The implicit rate of interest in the contract is 10% per year. Walton Tool Co. leases one of these machines on January 2, 2011.

Initial direct costs of $20,000 are incurred by Mullen on January 2, 2011, to obtain the lease. Walton’s incremental borrowing rate is determined to be 12%. The equipment is very specialized, and it is assumed it will have no salvage value after five years. Assume that the lease qualifies as a capital lease and a sales-type lease for lessee and lessor, respectively. Also assume that both the lessee and the lessor are on a calendar-year basis and that the lessee is aware of the lessor’s implicit interest rate.

Instructions:

1. Give all entries required on Walton’s books to record the lease of equipment from Mullen for the year 2011. The depreciation on owned equipment is computed once a year on the straight-line basis.

2. Give entries required on Mullen’s books to record the lease of equipment to Walton for the year 2011.

3. Prepare the balance sheet section involving lease balances for both the lessee’s and lessor’s financial statements at December 31, 2011.

4. Determine the amount of expense Walton will report relative to the lease for 2011 and the amount of revenue Mullen will report for the same period.