On January 1 , 20x5 , Puppies and Paws Inc ( Puppies ) leased a big puppy play gym from Doggie Doodles Corporation for a 7 year period . Annual payments are 4,500, and include $ 700 for repairs on the play gym . The first payment is due at the commencement of the lease . The interest rate implicit in the lease is 8 % and is known by Puppies as they are very smart . The incremental borrowing rate is 6 % ( as the Puppies are cute and can negotiate a lower rate with the bank ) . Puppies has an option to purchase the play gym at the end of the lease for $ 9,000 . The fair value of the play gym is estimated to be $ 7,000 at the end of the lease term . The guaranteed residual value on the play gym is $ 10,000 and Puppies expects to payout $ 8,000 on the residual value guarantee ( as the puppies get very excited and like to chew the play gym all day long ) . Puppies depreciates all assets on a straight - line basis . Assume that Puppies elects to account for the lease and non - lease components separate