Lessee entered into a 5-year noncancelable lease for machinery having an estimated economic life of 15 years and a fair value to the lessor at the lease inception of $420,000. Lessors implicit rate is unknown, and Lessees incremental borrowing rate is 12%. Lessee uses the straight-line method to depreciate property and equipment. The lease contains the following provisions:

• a.Rentalpaymentsof$5,300permonth,including$300forpropertytaxesandinsurance,payableattheendofeachmonth.
• b.An option allowing Lessee to renew the lease for two years at the expiration of the initial 5-year term. Lessee must pay a $100,000 termination penalty at the end of the initial 5-year term if the lease is not renewed for the two year period. If renewed, rental payments will remain the same.
• c.Lessee guarantees that the fair market value of the machine at the end of the lease will be at least $200,000. Lessee determined that an insurance company would charge a fee of $20,000 to assume liability for that guarantee. Lessee opted not to pay the fee and hence remains liable on the value guarantee.

Lessee has engaged your CPA firm to assist in determining the appropriate accounting for all aspects of the transaction. Your assignment is to prepare a formal accounting research memo that identifies the appropriate accounting for Lessee. Be sure to conclude your memo with the appropriate journal entries to be made by Lessee in accounting for the transaction. Any calculations that influence your reasoning or conclusion need to be explicitly incorporated into the memo so that the reader can verify the accuracy of those calculations. Note: base your analysis on current accounting guidance, not pending accounting guidance.