Makewell Hospital is leasing a piece of medical equipment from Medical Equipment Manufacturing (MEM) for five years. The equipment should last at least ten years with normal maintenance. They opted to lease rather than buy because they expect new and better medical equipment to be developed in the next few years. The fair value of the equipment is $2,000,000. The residual value of the equipment at the end of five years is $500,000. MEM spent $1,500,000 to build the equipment and they expect a 10% return in the lease. Makewell has a 12% marginal interest rate but knows the implicit rate that MEM has incorporated in the lease. The first payment is made when the lease is signed. MEM will incorporate in the lease payment $10,000 a year for executory costs. The equipment is to be returned to MEM at the end of the lease and there are no conditions under which Makewell would keep the equipment after the lease period.
Required:
A) Calculate the annual lease payment that MEM would charge if Makewell does not guarantee any residual (use this payment for parts B-E). What are the initial date journal entries for both Makewell and MEM
B) Is this a capital or operating lease?
C) Assume Makewell guaranteed $300,000 of the residual. What entries would MEM and Makewell make at the inception of the lease.
D) What entries would be made on the books for Makewell and MEM on the date of the second payment (for situation C).
E) Assume SuperMedical buys the equipment for MEM for $2,000,000 and subsequently leases it to Makewell. SuperMedical expects to earn 10% and will charge Makewell the same $10,000 for executory costs. Makewell guarantees $300,000 of the residual. Make day one entries for Makewell and SuperMedical. (No need to do anything about MEM.)