Lessor Entries; Direct-Financing Lease with Option to Purchase
Response to the following problem:
Castle Leasing Company signs a lease agreement on January 1, 2014, to lease electronic equipment to Jan Way Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement:
1. Jan Way has the option to purchase the equipment for $16,000 upon termination of the lease.
2. The equipment has a cost and fair value of $160,000 to Castle Leasing Company. The useful economic life is 2 years, with a salvage value of $16,000.
3. Jan Way Company is required to pay $5,000 each year to the lessor for executory costs.
4. Castle Leasing Company desires to earn a return of 10% on its investment.
5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.
Instructions
(a) Prepare the journal entries on the books of Castle Leasing to reflect the payments received under the lease and to recognize income for the years 2014 and 2015.
(b) Assuming that Jan Way Company exercises its option to purchase the equipment on December 31, 2015, prepare the journal entry to reflect the sale on Castle's books.