Vanity Jewelers Incorporated signed a lease agreement on July 1, 2018, to lease diamond-polishing equipment from Whitehead Industries. The following information is relevant to the lease agreement.
• The term of the non- cancellable lease is seven years with no renewal option. Payments of $ 45,500 are due on July 1 each year (at the beginning of each period).
• The fair value of the equipment at July 1, 2018, is $ 300,000. The equipment has an economic life of 10 years.
• Vanity Jewelers depreciates similar equipment it owns using the straight- line method over the economic life of the property.
• Vanity Jeweler’s incremental borrowing rate is 5%. Whitehead’s implicit rate on the lease is 8% and is known to Vanity Jewelers.
• There are no executory costs related to this lease.
Required
a. Determine the type of lease that Vanity Jewelers, the lessee, should record on its books.
b. Prepare all journal entries necessary on the books of Vanity Jewelers for 2018 and 2019. Vanity Jewelers has a December 31 year end.