Determining Type of Lease and Subsequent Accounting
Response to the following problem:
On January 1, 2010, the Alice Company leases equipment for five years, agreeing to pay $70,000 annually at the beginning of each year under the noncancelable lease. Superior Equipment Company, the lessor, agrees to pay all executory costs, estimated to be $3,450 per year. The cost and also fair value of the equipment is $305,000. Its estimated life is 10 years. The estimated residual value at the end of five years is $64,000 and is not guaranteed by Alice; at the end of 10 years, it is $5,000. There is no bargain purchase option in the lease nor any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. During 2010, Superior Equipment pays property taxes of $650, maintenance costs of $1,600, and insurance of $1,200. There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor. Straight-line depreciation is considered the appropriate method by both companies.
Required
1. Identify the type of lease involved for Alice Company and Superior Equipment Company and give reasons for your classifications.
2. Prepare appropriate journal entries for 2010 for the lessee and lessor.
3. If the residual value at the end of five years is guaranteed by Alice, identify the type of lease. Prepare journal entries for 2010 and 2011 for the lessee and lessor. Also prepare the journal entries for the lessee and the lessor when the lessee pays the guaranteed residual value.