a. On January 1, 2020, Lessor Able enters into a lease agreement to lease a vehicle to Lessee Baker for three years for lease payments of $2,900, payable annually at the end of each year. The Lessee & the Lessor each incur initial direct costs of $200 to enter into the lease. At the beginning of the lease, both the carrying amount (on Lessor’s books) and fair value of the vehicle are $10,000 and the amount the lessor expects to derive from the vehicle at the end of Year 3 is $3,000. The lessee has an option to purchase the vehicle at the end of the initial lease term at $3,500. The economic life of the vehicle is four years, with zero residual expected at that time.

The lessee concludes that it does not have a significant economic incentive to exercise the purchase option and therefore determines the lease term to be three years. Thus, the leased vehicle will be returned to the Lessor at the end of three years.

This is a Finance lease for Lessee and a Sales-Type lease for Lessor. Why? Here, the lease term is 75% or more of the useful life of the asset.

REQUIRED:

1. Compute the initial lease liability. What is the implicit rate the lessor charges the lessee?

2. What is the amortization period for the right-of-use asset?

3. Make the Lessee’s entries for the three years. Prepare the amortization table.

4. At the end of Year 3, what is the balance in lease liability and right-of-use asset, respectively?

b. Assume the same facts as in Leases Problem A, except that the life of the asset is 5 years now, with zero residual value anticipated at the end of the fifth year. (NOTE: you cannot just change the useful life of an asset to get a different accounting treatment; all I’m doing here is asking you to assume a different useful life – assume it really does have a different useful life – so that you can see the different accounting.) Accordingly, lessee accounts for the lease of the vehicle as an operating lease.

REQUIRED:

1. Record the lessee’s entries for all three years of the lease term.
2. Compare the lease expense for the Lessee under an Operating lease to that under a Finance lease.

c. Assume the same facts as in Leases Problem B. Accordingly, the lessor accounts for the lease of the vehicle as an Operating lease.

REQUIRED: Make the Lessor’s entries for all three years of the lease term.