The following summarizes the terms of a lease entered into between Dove Company (lessor) and Hawk Company (lessee) entered into on January 1, 2016:
1. The lease term is 4 years. The lease is noncancelable and requires equal payments of $32,923.45 the end of each year.
2. The cost and also fair value of the equipment to Dove at the inception of the lease is $100,000. The equipment has an estimated economic life of 4 years and has a zero estimated residual value.
3. Hawk does not guarantee the residual value.
4. Hawk agrees to pay costs for maintenance estimated at $4,000 per year. This amount is not included in the payments in 1 above.
5. There is no bargain purchase element and the equipment reverts to Dove at the end of the 4 years.
6. Hawks incremental borrowing rate is 12.5% per year.
7. Hawk depreciates similar equipment using straight line.
8. For Dove, the implicit rate in the lease is 12% and Hawk knows this rate.
Required:
1. Explain the nature of this lease to Hawk.
2. Prepare all of the necessary accounting entries in 2016 for Hawk.
3. Prepare for Hawk, the necessary accounting entries for the LAST payment to the lessor and for termination of the lease.