On 12/31/16, DEF Corp. leased equipment to GHI Corp. The following information pertains to the lease agreement: The terms of the non-cancelable lease are 5 years with no renewal option. At the termination of the lease, the equipment reverts back to the lessor. Equal rental payments of $5,000 are due at the beginning of each year starting 12/31/16. The equipment is not of a specialized use. The cost of the asset to the lessor is $20,000. The FMV of the asset at 12/31/16 is $40,000. The equipment has an economic life of 6 years. The equipment has an expected residual value of $1,600, though DEF Corp. has guaranteed a residual value of $2,000 to GHI Corp. DEF Corp. depreciates all of its equipment on a straight-line basis. The agreement requires equal annual rental payments, starting 12/31/16. w DEF Corp.'s incremental borrowing rate is 7% per year. The implicit rate is also 7%. Collectability of the lease payments is probable. The present value of the lease payments, rounded to the nearest dollar, is $21.936 (N = 5, 1 = 7%, PMT = 6,000, FV = 0, CPT PV using annuity due) The present value of the guaranteed residual value, rounded to the nearest dollar, is $1,426 (N = 5, I = 7%, PMT = 0. F = 2,000, CPT PV using annuity due) The present value of the guaranteed residual expected to be owed, rounded to the nearest dollar, is $285 (N = 5,1 = 7%, PMT = 0. FV = 400, CPT PV using annuity due) . . . a. Use the lease classification test template below to determine whether this lease is a finance or operating lease. A response to each test must be shown to get full credit, 1. What type of lease is this (finance or operating)? H. Lease classification test (complete template with a YES/NO response for each):

1. Transfer of ownership 2. Purchase option (at end of lease term for 75% of its economic life (includes bargain renewal period if one exists) 1. If PV of lease payments > 90% of FMV of asset at inception of lease. For lessee, in payment, include guaranteed residual value and cost of bargain purchase option; include only executory costs that are part of fixed lease payment i.e. insurance). Discount rate is lessor's implicit rate (use lessee's incremental borrowing rate if impractical to determine implicit rate.) 2. Alternative Use Test b. Prepare the journal entries for the lessee at the inception of the lease on 12/31/16, including the first lease payment:

The following is an amortization schedule for the lease liability: Effective Interest Amortization Schedule: 796 Interest Lease Payment Date Expense 12/31/2016 12/31/2016 5.000 5.000 12/31/2017 1.205 Lease Lease Reduction Liability 22.221 5.000 17.221 3.795 13.426 4,060 9.366 5.022 4648 374 12/31/2018 5.000 940 12/31/2019 5.000 656 12/31/2020 5.000 352 c. Prepare the journal entries for the lessee at the end of the first year of the lease on 12/31/17, including amortization of the asset and interest expense associated with the lease liability for the second lease payment: