Problem 1

On January 1, 2016, Breshing Company enters into a noncancelable lease, with no renewal option, to lease a new piece of equipment from Edwards Leasing Company. The lease term is for three years and the lease payments are made on December 31 of each year.

The equipment cost Edwards $250,000, it has a fair value of $300,000 and a useful life of four years with no residual value. The equipment reverts to Edwards upon termination of the lease. Breshing guarantees a $100,000 residual value at the end of the lease term.

Both Breshing Company and Edwards Company depreciate all machinery that they own on a straight-line basis. Breshings incremental borrowing rate is 8 percent per year and Breshing Company does not have knowledge of the 5 percent implicit rate used by Edwards.

Collectability of the future lease payments is reasonably predictable, and no additional costs related to the lease are expected.

Required:

1. Determine the annual lease payments, as set by the lessor.

2. Determine the amount of the minimum lease payments that will be capitalized by the lessee.

3. What type of lease is this to Breshing Company? Be specific in justifying your answer.

4. What type of lease is this to Edwards Company? Be specific in justifying your answer.

5. Prepare any necessary journal entries on January 1, 2016, for both parties.

6. Prepare any necessary journal entries on December 31, 2106 for both parties.

7. Which party will depreciate the asset? What is the amount of depreciation expense that will be recognized by that party? Be sure to show all calculations.

8. How would your answer change if the residual value were unguaranteed? (You just need to provide a narrative explanation of its impact on both parties. I am not looking for calculations with the new assumptions).

Problem 2

On January 1, 2016, Charloff Company entered into an agreement to lease a piece of machinery from Pierre Corporation for four years. The machinery had a cost and fair value of $800,000 and a useful life of seven years. The lease called for annual rental payments on December 31 of each year, starting on December 31, 2016. At the end of the lease term, Charloff has the option to purchase the equipment for $30,000, which is significantly less than what the fair market value of the equipment will be at that time.

Charloffs incremental borrowing rate is 10% and Pierres implicit borrowing rate is 8%. Charloff is unaware of Pierres implicit rate.

Collectability of the future lease payments is reasonably predictable, and no additional costs related to the lease are expected.

Required:

1. What type of lease is this for Pierre? (Be specific and provide justification)

2. What type of lease is this for Charloff?

3. Determine the annual lease payments, as set by Pierre Corporation.

4. Determine the minimum lease payments, as calculated by Charloff.

5. Prepare the entry on the date of the lease inception for both the lessee and lessor.

6. Prepare the lessees amortization schedule for the term of the lease.

7. Prepare the entry for the first interest payment for both the lessee and lessor.

8. Prepare the entry to record depreciation expense for the asset for the year 2017, assuming that Charloff uses the straight-line method.

9. Complete parts 3-6, assuming that the lease payments are made each January 1, starting on January 1, 2016 instead of on December 31^st of each year.