On January 1, 2016, Stimpson Company sells land to Barker Company for $2.5 million and then immediately leases it back. The relevant information is as follows:
1. The land was carried on Stimpson’s books at a value of $2 million.
2. The term of the noncancelable lease is 25 years.
3. The lease agreement requires equal rental payments of $363,746 at the end of each year.
4. The incremental borrowing rate of Stimpson is 15%. Stimpson is aware that Barker set the annual rental to ensure a rate of return of 14%.
5. The land has a fair value of $2.5 million on January 1, 2016.
6. Stimpson has the option of purchasing the land for $150 at the end of 25 years.
7. Stimpson pays all executory costs. These costs consist of insurance and property taxes amounting to $12,000 per year.
8. There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor, and the collectibility of the rentals is reasonably assured.
Required:
1. Prepare the journal entries for the seller-lessee, Stimpson, for 2016 to reflect the sale and leaseback agreement. In calculating the present value of the lease payments, ignore the $150 bargain purchase option as immaterial.
2. Next Level Describe briefly the accounting treatment of the gain by the seller-lessee. Prepare any journal entry that Stimpson should make relating to the gain at year- end 2016.