Question
On January 1, 2019, Fargo Corp. enters into a ten-year non-cancellable lease with Wells Ltd. for equipment having an estimated useful life of 11 years
On January 1, 2019, Fargo Corp. enters into a ten-year non-cancellable lease with Wells Ltd. for equipment having an estimated useful life of 11 years and a fair value of $6,000,000. Fargo's incremental borrowing rate is 8% per annum (4% per 6 months), but they do not know Wells implicit rate. Fargo uses the straight-line method to depreciate assets. The lease contains the following provisions:
1. Semi-annual lease payments of $438,000 (including $38,000 for property taxes executory costs), payable on January 1 and July 1 of each year (semi-annual payments).
2. A guarantee by Fargo Corp. that Wells Ltd. will realize $200,000 from selling the asset at the expiration of the lease. The asset reverts back to Wells Ltd. at the end of the lease. Both companies adhere to ASPE and the fiscal year end of Fargo Corp. is December 31st.
Required:
a) What kind of lease is this to Fargo Corp? Why?
b) Prepare the journal entries that Fargo would record for the period January 1, 2019 up to and including December 31, 2019. Include an amortization schedule for the period January 1, 2019 to January 1, 2020 and do NOT worry about preparing the entire amortization schedule too time consuming!
c) Prepare the journal entries that Fargo would record for the period January 1, 2019 up to and including December 31, 2019 under the assumption that the residual value is not guaranteed by Fargo Corp [as it was in part (b)]. Include an amortization schedule for the period January 1, 2019 to January 1, 2020 and do NOT worry about preparing the entire amortization schedule too time consuming!
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