Question # 2

Island Creamery, leases its ice cream making equipment from Big Rock Finance Company under the following lease terms:

The lease term is five years, non-cancellable, and requires equal rental payments of $56,926 due at the beginning of each year starting January 1, 2019.

Upon inception of the lease on January 1, 2019, Big Rockpurchased the equipment at its fair value of $280,000 and immediately transferred it to Island Creamery. The equipment has an estimated economic life of five years, and an expected payout under the residual value guarantee is $20,000.

The lease contains no renewal options, and the equipment reverts to Big Rock Finance Company upon termination of the lease.

Island 's incremental borrowing rate is 5%; the rate implicit in the lease is also 4%. The implicit rate in the lease is not readily determinable by Island.

Island depreciates similar equipment that it owns on a straight-line basis.

Both companies have December 31 year-ends.

Required:

1. Evaluate how the lessor should account for the lease transaction.

2. Prepare the journal entries on January 1, 2019, December 31, 2019, and January 1, 2020 for the lessor.