Clevland Company manufactures an equipment with an estimated economic life of 5 years and leases it to Irving inc. for a period of 3 years. The normal selling price of the equipment is $39,750, and its guaranteed residual value at the end of the lease term is 8,000 with $5,000 expected residual value. Irving will pay annual lease payments of $12,000 at the beginning of each year. Clevland incurred costs of $20,000 in manufacturing the equipment and $4,000 in sales commissions in closing the lease. Clevland has determined that the collectibility of the lease payments is probable and that the implicit interest rate is 8%, which is known to the lessee.

Instructions

(a) Show how the lease payment is derived by the lessor and discuss the nature of this lease in relation to the lessor.

(b) Prepare all of the lessor's journal entries for 1/1/2017, 12/31/2017, and 12/31/2019 assuming $7,500 residual value for the equipment on 12/31/2019.