On May 1, 2016, Gia Equipment Manufacturers (GEM) agreed to lease machinery to Jason Associates. GEM paid $ 2,000,000 to produce the machine and carries it at this amount in its inventory. The fair value (current selling price) of the machine is $ 2,104,317. The lease terms are listed below:
• Annual rental payments of $ 345,000 are due at the beginning of each year, beginning on May 1, 2016. These minimum rental payments do not include any executory costs.
• Lease term is eight years.
• There is a bargain purchase option to acquire the asset at the end of six years for $ 700,000. Jason Associates expects to exercise the bargain purchase option.
• The economic life of the asset is 10 years.
• The lessor’s 9% implicit rate is known to Jason Associates.
• The lessee’s incremental borrowing rate is 12%.
• Annual maintenance is $ 20,000 and annual property tax is $ 35,000. The lessee pays both at the end of the year and charges these payments to general and administrative expenses.
• GEM has no material uncertainties regarding future costs to be incurred under the lease and collectability is reasonably assured.
• Jason depreciates similar machinery owned using the straight-line method over 10 years.
Required
a. Determine the lease classification for both the lessor and lessee.
b. Prepare the amortization table for the entire lease term.
c. Prepare the journal entries for the lessee during 2016.
d. Prepare the journal entries for the lessor during 2016.