[5 POINTS TOTAL] Emma Leasing Company agrees to lease equipment to Clea corporation on January 1, 2017. The following information relates to the lease agreement.

• The term of the lease is 12 years with no renewal option, and the machinery has an estimated economic life of 16 years.
• The cost of the machinery is $330,000, and the fair value of the asset on January 1, 2017, is $475,000.
• At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $40,000. Clea estimates that the expected residual value at the end of the lease term will be $40,000. Clea amortizes all its leased equipment on a straight-line basis.
• The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
• The collectability of the lease payments is probable.
• Emma desires a 4% rate of return on its investments. Cleas incremental borrowing rate is 5%, and the lessors implicit rate is known to Clea.
• Both lessor and lessee have December 31 fiscal year ends.

ANSWER THE FOLLOWING

1. What type of lease is this to the lessee and lessor. Explain why.
2. Calculate the amount of the annual rental payment. Ignore minor rounding.
3. Prepare the journal entries Clea would make in 2017 and 2018 related to the lease arrangement.
4. Prepare the journal entries Emma would make in 2017 and 2018 related to the lease arrangement.
5. At the end of the lease term, when Clea is returning the asset to Emma, Clea and Emma learn that asset is only worth $30,000 (Clea guaranteed $40,000). What entry would Emma make upon the return of the asset?

Answer rating: 100% (QA)

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