On January 1, 2020, Lessor Inc., a manufacturer of machinery and equipment, leased equipment with a fair value of $ 222,365 to Lessee, Inc. Both companies accounted for the contract appropriately: the lessor as a sale-type and the lessee as a financier .

The lease is for 7 years (the useful life of the asset is 10 years) and ends on December 31, 2024. The first of 7 equal payments of $ 40,406 was made on January 1, 2020. Lessor, Inc. built the asset at a cost of $ 45,100 and reported it in their accounts as inventory. At the end of the contract the asset will be returned to the lessor.

Suppose that the lease payments and the interest rate that the lessee and lessor used to record the "receivable lease" and the "lease liability" were exactly the same. As of January 1, 2020, the present value of all lease payments (including a residual value of $ 35,000) for 7 years at 12% was $ 222,365. However, the present value of 7-year rental payments at 12% only was $ 206,533. There are no other costs associated with this contract.

What is the amount of gross profit from the sale of the equipment that must be recognized by Lessor, Inc. for the period ending December 31, 2020?

Select one:

a. $ 0 because the contract was not classified as direct financing.

b. $ 177,265 because the contract was classified as a sale type.

c. $ 194,865 because the contract was classified as a sale type.

d. $ 177,265 only if the residual value is 100% guaranteed.

Using the data from the previous question, in the first journal entry to register the contract on 1/1/20, the lessee wrote down the "lease liability" for the greater of the two present values that are presented. Based on this information, we can conclude that

Select one:

a. The tenant guaranteed the residual value but understands that he will not have to pay it at the end of the contraca

b. The lessee guaranteed the residual value.

c. The tenant did not guarantee the residual value but understands that he will have to pay it at the end of the contract.

d. The lessor used an insurer to guarantee the residual value. and. The tenant guaranteed the residual value and understands that he will have to pay it at the end of the contract.