Nyonya agrees to lease equipment to Tuan on January 1, 2019. The following information relates to the lease agreement.

1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.

2. The cost of the machinery is 1,312,500, and the fair value of the asset on January 1, 2019, is 1,750,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of 125,000. Tuan estimates that the expected residual value at the end of the lease term will be 125,000. Tuan amortizes all of its leased equipment on a straight-line basis.

4. The lease agreement requires equal annual rental payments, beginning on January 1, 2019.

5. The collectability of the lease payments is probable.

6. Nyonya desires a 5% rate of return on its investments. Tuan's incremental borrowing rate is 6%, and the lessor's implicit rate is unknown.

Instructions

a. Discuss the nature of this lease for the lessor.

b. Calculate the amount of the annual rental payment required.

c. Compute the value of the lease liability to the lessee.

d. Prepare the journal entries Tuan would make in 2019 and 2020 related to the lease arrangement.

e. Prepare the journal entries Nyonya would make in 2019 and 2020 related to the lease arrangement.

f. Suppose Tuan expects the residual value at the end of the lease term to be 100,000 but still guarantees a residual of 125,000. Compute the value of the lease liability at lease commencement.