Problem $8$

Lessee $-$ No Guaranteed Residual Value

Wood Company enters into a lease agreement with Postner Co$.$ on Jan $1,1999,$ to lease a machine to be used in its

manufacturing operations. The following data pertain to this agreement.

a$.$ The term of the noncancelable lease is $3$ years, with no residual value at the end of the lease term.

Payments of $$37,500$ are due at Dec $31$ of each year. The first payment in advance is paid on Jan. $1,1999.$

b$.$ The fair value of the machine on Jan $1,1999$ is $$125,000.$ The machine has an economic life of $8$ years, with no

salvage $($residual$)$ value. The machine reverts to the lessor upon the termination of the lease.

c$.$ W and P companies use the straight$-$line method to depreciate equipment.

d$.$ W$\text{'}$s incremental borrowing rate is $12\%$ and the implicit rate is unknown.

Required:

Is this a capital lease or operating lease. Why?

Instructions: Prepare journal entries on the books of the lessee through the first year of the lease $.$

The accounting period of both companies ends on December $31.$