Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.

1. The lease term is 10 years, non-cancelable, and requires equal rental payments of $30,300 due at the beginning of each year starting January 1, 2020.

2. The equipment has a fair value at the commencement of the lease (January 1, 2020) of $242,741 and a cost of $180,000 on King Finance’s books. It also has an estimated economic life of 15 years and anexpected residual value of $45,000, though Goring Dairy has guaranteed a residual value of $50,000 to King Finance.

3. The lease contains no renewal options, and the equipment reverts to King Finance upon termination of the lease. The equipment is not of a specialized use.

4. Goring Dairy’s incremental borrowing rate is 8% per year. The implicit rate is also 8%.

5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.

6. Collectibility of the payments is probable.

Instructions

a. Evaluate the criteria for classification of the lease, and describe the nature of the lease. In general, discuss how the lessee and lessor should account for the lease transaction.

b. Prepare the journal entries for the lessee and lessor at January 1, 2020, and December 31, 2020 (the lessee’s and lessor’s year-end). Assume no reversing entries.

c. What would have been the amount of the initial lease liability recorded by the lessee upon the commencement of the lease if:

1. The residual value of $50,000 had been guaranteed by a third party, not the lessee?

2. The residual value of $50,000 had not been guaranteed at all?

d. On the lessor’s books, what would be the amount recorded as the lease receivable at the commencement of the lease, assuming:

1. The residual value of $50,000 had been guaranteed by a third party?

2. The residual value of $50,000 had not been guaranteed at all?