On January 1, 2013, Baldwin Products, as lessee, leases a machine used in its operations. The annual lease payment of $10,000 is due on December 31 of 2013, 2014, and 2015. The machine reverts to the lessor at the end of the three years. The lessor can either sell the machine or lease it to another firm for the remainder of its expected total useful life of five years. Baldwin Products could borrow on a three-year collateralized loan at 8%. The market value of the machine at the inception of the lease is $30,000. Round all amounts to the nearest dollar.
a. Does this lease qualify as an operating lease or a capital lease?
b. Assume that this lease qualifies as an operating lease. Give the journal entries for Baldwin Products over the three-year period.
c. Assume this lease qualifies as a capital lease. Repeat part b.
d. Compute the total expenses for the three-year period under the operating and capital lease methods.