Problem: On August 1, 1993, Creative Works (lessee) and Netsis Computer Industries (lessor) signed a lease with the following terms:
1. Term: 5 years
2. Annual payments of $39,000
3. Implicit interest rate (not known to lessee) 10%
4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $168,834
6. Cost of asset $130,000 (not known to lessee)
7. Incremental borrowing rate: 12%
8. First payment due 8/1/93
9. Estimated useful life of asset: 7 years
10. No collection or cost uncertainties for lessor
11. Est. fair value of asset at end of lease: $10,000
12. The residual value is NOT guaranteed by lessee
13. A commission of 1% of the sales price (PVMLP) is paid to the salesperson who negotiated the lease.
14. Lessor and lessee both use straight-line depreciation method for fixed assets.
Answer the following questions:
a. Classify this lease from the perspective of the lessee. Explain.
b. Prepare all necessary journal entries for Creative Works at 8/1/93 and 12/31/93 (end of fiscal year).
c. Classify this lease from the perspective of the lessor. Explain.
d. Prepare all necessary journal entries for Netsis Computer Industries (CCI) at 8/1/93 and 12/31/93 (end of fiscal year).