On December 31, 2013, Yard Art Landscaping leased a delivery truck from Branch Motors. Branch paid $40,000 for the truck. Its retail value is $45,114.

The lease agreement specified annual payments of $11,000 beginning December 31, 2013, the inception of the lease, and at each December 31 through 2016. Branch Motors’ interest rate for determining payments was 10%.

At the end of the four-year lease term (December 31, 2017) the truck was expected to be worth $15,000. The estimated useful life of the truck is five years with no salvage value. Both companies use straight-line depreciation.

Yard Art guaranteed a residual value of $6,000. Guarantor Assurance Corporation was engaged to guarantee a residual value of $11,000, but with a deductible equal to any amount paid by the lessee ($11,000 reduced by any amount paid by the lessee). Yard Art’s incremental borrowing rate is 9%.

A $1,000 per year maintenance agreement was arranged for the truck with an outside service firm. As an expediency, Branch Motors agreed to pay this fee. It is, however, reflected in the $11,000 lease payments.

Collectibility of the lease payments by Yard Art is reasonably predictable and there are no costs to the lessor that are yet to be incurred.

Required:

1. How should this lease be classified by Yard Art Landscaping (the lessee)? Why?

2. Calculate the amount Yard Art Landscaping would record as a leased asset and a lease liability.

3. How should this lease be classified by Branch Motors (the lessor)? Why?

4. Show how Branch Motors calculated the $11,000 annual lease payments.

5. Calculate the amount Branch Motors would record as sales revenue.

6. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2013.

7. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Yard Art.

8. Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Branch Motors.

9. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2014.

10. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2016 (the final lease payment).

11. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2017 (the end of the lease term), assuming the truck is returned to the lessor and the actual residual value of the truck was $4,000 on that date.