Fox Company, a manufacturer of heavy equipment, leased an equipment to Tiger Inc., on January 1, 2021. The lease provisions were as follows:

Leas term 5 years

Useful life of equipment 8 years

Fair market value of the equipment $200,000

Cost of the equipment $160,000

Annual lease payments Beginning 1-1-21 and each Dec. 31, 2021-2024 $ 44,240

Residual Value (not guaranteed) $ 25,000

Lessee initial direct costs $ 10,000

Lessor initial direct costs $ 8,000

Lessees incremental borrowing rate 9%

Lessors implicit rate (readily determinable) 10%

At the end of the lease term, Tiger will return the equipment to Fox. Since Tiger is a good credit risk, Fox is certain to collect the lease payments.

REQUIRED:

1. How should the lessee and lessor classify this lease?
2. Prepare the necessary journal entries related to the lease in the books of the lessee and lessor for the lease term.

LEASE AMORTIZATION SCHEDULE FOR LESSEE

RESIDUAL VALUE NOT GUARANTEED

Reduction of Lease

Date Lease payment Interest Liability Liability

1/1/21 $184,475

1/1/21 $44,240 $ 0.0 $44,240 $140,235

12/31/21 $44,240 $14,024 $30,216 $110,019

12/31/22 $44,240 $11,002 $33,238 $ 76,781

12/31/23 $44,240 $ 7678 $36,562 $ 40,219

12/31/24 $44,240 $ 4,022 $40,218 0

LEASE AMORTIZATION SCHEDULE FOR LESSOR

Reduction of Net Investment

Date Lease payment Interest Investment in lease

1/1/21 $200,000

1/1/21 $44,240 $ 0.0 $44,240 $155,760

12/31/21 $44,240 $15,576 $28,664 $127,096

12/31/22 $44,240 $12,710 $31,530 $ 95,566

12/31/23 $44,240 $ 9,557 $34,683 $ 60,883

12/31/24 $44,240 $ 6,088 $38,152 $ 22,731

12/31/25 $25,000 $ 2,273 $22,727 $ 0.0

Please help explain this problem