On January 1, 2021, Katie Company enters into a nine-year noncancelable lease for equipment having an estimated useful life of 10 years and a fair value to the lessor, Marco Corp., at the inception of the lease of $4,000,000. Katies incremental borrowing rate is 8%. Katie uses the straight-line method to depreciate its assets.

The lease contains the following provisions:

1. Rental payments of $266,000 are payable at the beginning of each six-month period.

2. An option allowing the Katie to extend the lease one year beyond the lease term at the same rental cost as the original lease term. Katie Company anticipates taking advantage of the one year least extension option.

3. A guarantee by Katie Company that Marco Corp. will realize $200,000 from selling the asset at the expiration of the lease. The value of the equipment at the end of the lease expected to be $120,000.

Questions:

2.1 How should Katie Company classify the lease and why?

2.2 What is the present value of the lease payments (round to the nearest dollar) A. for purposes of classifying the lease? B. for purposes of measuring the lease liability?

2.3 What journal entries does Katie record during the first year of the lease? (Include an amortization schedule through 12/31/21 and round to the nearest dollar)

2.4 Describe the difference, from the lessees perspective, between a finance lease and an operating lease, for each of the following: (1) Evaluation of the lease for classification purposes. (2) Computations and journal entry to record the lease at inception. (3) Computations and journal entry to record lease payments. (4) Computations and journal entry to record any other amounts related to the lease.