Question

Gustav Leasing Company agrees to lease equipment to Julliard Corporation on January 1, 2017. The

following information relates to the lease agreement.

1. The term of the lease is 6 years with no renewal option, and the machinery has an estimated

economic life of 8 years.

2. The cost of the machinery is $310,000, and the fair value of the asset on January 1, 2017, is $424,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of

$35,000. Julliard estimates that the expected residual value at the end of the lease term will be $35,000.

Julliard amortizes all of its leased equipment on a straight-line basis.

4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.

5. The collectability of the lease payments is probable.

6. Gustav desires a 6% rate of return on its investments. Julliard’s incremental borrowing rate is 8%, and

the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31)

(a) Discuss the nature of this lease for both the lessee and the lessor.

(b) Calculate the amount of the annual rental payment required.

(c) Compute the value of the lease liability to the lessee.

(d) Prepare the journal entries Julliard would make in 2017 and 2018 related to the lease arrangement.

(e) Prepare the journal entries Gustav would make in 2017 and 2018 related to the lease arrangement.

(f) Suppose Julliard expects the residual value at the end of the lease term to be $28,000 but still

guarantees a residual of $35,000. Compute the value of the lease liability at lease commencement.

(g) Suppose the residual value is unguaranteed, how would Gustav’s journal entries change?

Answer 1