Lehman Dairy leases its milking equipment from Chavez Finance Company under the following lease terms.

The lease term is 8 years, noncancelable, and requires equal rental payments due at the beginning of each year starting May 1, 2022.

The equipment has a fair value of $475,000, and cost Chavez $350,000, at the inception of the lease (May 1, 2022).

Lehman Dairy has the option to purchase the equipment for $12,600, at the end of the lease. This represents a signficant discount on the equipment.

The estimated economic life of the equipment is 10 years, and a residual value (which is guaranteed by Lehman Dairy) of $35,000. If the purchase option is not exercised, Lehman Dairy expects to pay $21,000 under the guaranteed residual value.

The lease contains no renewable options, and the equipment reverts to Chavez Finance Company upon termination of the lease, if the purchase option is not exercised.

Lehman Dairys incremental borrowing rate is 9% per year. Chavezs implicit rate is 7% and is known to Lehman Dairy.

Collectability of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Present value of 1 for 8 periods at 7% 0.58201 Present value of 1 for 8 periods at 9% 0.50187

Present value of an ordinary annuity for 8 periods at 7% 5.97130

Present value of an ordinary annuity for 8 periods at 9% 5.53482

Present value of an annuity due for 8 periods at 7% 6.38929

Present value of an annuity due for 8 periods at 9% 6.03295

Instructions (Assume the accounting period ends on December 31.)

(a) Calculate the required payment Chavez Finance requires to earn the Fair Value of the asset.

(b) Lehman Dairy is able to negotiate the payment down to $73,000 per year. Compute the present value of the minimum lease payments for both the lessee and lessor.

(c) What type of lease is this for the lessee? For the lessor?

(d) Prepare the journal entries Chavez would make in the first full calendar year of the lease (January 1, 2023 - December 31, 2023) related to the lease arrangement.

(e) Prepare the journal entries Lehman would make in the first full calendar year of the lease (January 1, 2023 - December 31, 2023) related to the lease arrangement.