Question:

For both the premises lease and the CNC machining center leases, explain how the leases will be classified for accounting purposes, and why. [Hint: Find the classification criteria in the CPAC Hdbk, and match case facts to Hdbk criteria as shown in the sample case. Check for special rules that may apply to the premises rental agreement.] Show the adjusting journal entries (if needed) required at the initiation of each lease.

Information below

Premises

NFI Corporation entered into a rental agreement for a small industrial unit on July 1, 2020. The landlord had offered to sell the unit to NFI, but Mitch felt the price was too steep ($850,000 including $300,000 for the land and $550,000 for the building). Mitch wanted to ensure the location was suitable before he purchased. Instead, he agreed to a 4 year rental agreement, with payment of $9,350 due on the first of each month. Mitch recorded the July 1 payment as Rent expense

CNC machining center

The computer numeric-controlled (CNC) machining center is the largest and most critical piece of equipment in the shop. It can perform a variety of milling operations at very high levels of precision. Mitch expects it to have an 80% usage rate. The CNC machining center lists for $420,000. With software updates and regular maintenance, it has an estimated useful life of 15 years, even though Mitch believes obsolescence will be a concern within 5-

10 years. NFI agreed to lease the machining center for 6 years. It was installed on July 1, 2020. Annual payments of $72,200 + 13% HSTare due annually on October 1, starting July 1, 2020. In order to close the deal, NFI had to guarantee a residual value of $50,000. Mitch expects that the center will be worth about $75,000 by the time the lease expires, so he does not expect to make any payments under the guarantee.

Mitch recorded the July 1 payment for the CNC machining center as Lease expense - CNC.