On January 1st , 2006, the ABC Company entered into the lease where they settled to make five annual payments of $224,000 beginning December 31st , 2006. They accurately computed that, PV of minimum lease payments was $894,000. Lease asset, a high printing press, had the fair market value of $1 million at 1/1/06. There was a $1 purchase option so they knew lessor’s implicit rate of 8%. ABC treated this lease as the operating lease, although they thought that a $1 purchase option was really good deal.
ABC’s auditors didn’t even look at this lease last year. Though, at 12/31/07 their new auditors looked closely, and they told ABC that this must have been recorded as the capital lease, since the purchase option was bargain.
Create the entries which fix this error. ABC usually depreciated assets like printing presses over five years. Suppose that the 12/31/07 books are still open.