Question

On January 1, 2017, Louis Corp. enters into a ten-year non-cancellable lease with Coles Ltd. for equipment having an estimated useful life of 11 years and a fair value of $6,000,000. Louis's incremental borrowing rate is 8%, but they do not know Coles implicit rate. Louis uses the straight-line method to depreciate assets. The lease contains the following provisions:

1. Semi-annual lease payments of $438,000 (including $38,000 for property taxes), payable on January 1 and July 1 of each year.

2. A guarantee by Louis Corp. that Coles Ltd. will realize $200,000 from selling the asset at the expiration of the lease (residual value).

Both companies adhere to ASPE.

Instructions

a. Calculate the undiscounted minimum lease payments over the life of the lease.

b. Calculate the present value of the minimum lease payments.

c. What kind of lease is this to Louis Corp.? Why?

d. Present the journal entries that Louis would record during the first year of the lease. Include an amortization schedule through January 1, 2018 and round values to the nearest dollar.