E21-12

(L02,4)

(Lessee-Lessor Entries; Sales-Type Lease with Bargain Purchase Option)

On January 1, 2017, Bensen

Company leased equipment to Flynn Corporation. The following information pertains to this lease.

1.

The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equip-

ment for $1,000, while the expected residual value at the end of the lease is $5,000.

2.

Equal rental payments are due on January 1 of each year, beginning in 2017.

3.

The fair value of the equipment on January 1, 2017, is $150,000, and its cost is $120,000.

4.

The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.

5.

Bensen set the annual rental to ensure a 5% rate of return. Flynns incremental borrowing rate is 6%, and the implicit rate

of the lessor is unknown.

6.

Collectibility of lease payments by the lessor is probable.

Instructions

(Both the lessor and the lessees accounting periods end on December 31.)

(a)

Discuss the nature of this lease to Bensen and Flynn.

(b)

Calculate the amount of the annual rental payment.

(c)

Prepare all the necessary journal entries for Bensen for 2017.

(d)

Suppose the collectibility of the lease payments was not probable for Bensen. Prepare all necessary journal entries for

the company in 2017.

(e)

Prepare all the necessary journal entries for Flynn for 2017.

(f)

Discuss the effect on the journal entry for Flynn at lease commencement, assuming initial direct costs of $2,000 are

incurred by Flynn to negotiate the lease.