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On January 1, 2021, Nuggets, Inc. engaged in a lease agreement with Heat Manufacturing for the use of equipment with an estimated economic life of
On January 1, 2021, Nuggets, Inc. engaged in a lease agreement with Heat Manufacturing for the use of equipment with an estimated economic life of five years. The term of the lease is four years and requires four annual payments of $100,000 beginning January 1, 2021 and continuing on December 31 of every year from 2021 to 2023. The equipment is not specialized. Heat Manufacturing incurred $5,000 in costs related to obtaining credit reports on Nuggets and closing the lease arrangement. Nuggets incurred no initial direct costs. The equipment cost Heat $350,000 to manufacture, and the fair value of the equipment is $379,761. The lease terms follow: - Nuggets guarantees that the equipment returned to Heat on December 31, 2024 will be worth $30,000. - There is no transfer of the asset at the end of the lease term and no purchase option. - The rate implicit in the lease is 8% and is known to Nuggets. - Assume that Nuggets estimates that the fair value of the equipment at the end of the lease will be worth $30,000. Required: a. What type of lease has each party signed? Explain in terms of ASC 842. (2 pts) b. Prepare all 2021 journal entries for both the lessor and lessee. (12 pts) c. Prepare all 2024 journal entries for both the lessor and lessee, assuming that the fair value of the equipment at the end of the lease (12/31/24) is $30,000. How would your answer differ if the equipment's fair value is $25,000 at the end of the lease? (6 pts) d. Now assume that the $30,000 residual value is estimated by Heat and is not guaranteed. Answer parts a., b., and c. above under this for Heat (Lessor) only. (8 pts)
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