Question

On January 1, 2019, Lavery Corporation leased equipment to Flynn Corporation. Both Lavery and Flynn use ASPE and have calendar year-ends. The following information pertains to this lease

. 1. The term of the non-cancellable lease is six years with no renewal option. The equipment reverts to the lessor at the termination of the lease, at which time it is expected to have a residual value of $6,000. Flynn depreciates all of its equipment on a straight-line basis.

2. Equal rental payments are due January 1 of each year beginning in 2019.

3. The equipment’s fair value on January 1, 2019, is $144,000.

4. The equipment has an economic life of seven years.

5. Lavery set the annual rental to ensure a 9% rate of return (implicit rate). Flynn’s incremental borrowing rate is 10% and the lessor’s implicit rate is unknown to the lessee (Flynn).

6. Collectability of lease payments is reasonably predictable and there are no important uncertainties about any unreimbursable costs that have not yet been incurred by the lessor.

Required:

(a) Explain clearly why this lease is a capital lease to Flynn.

(b) Using time value of money tables (attached) or a financial calculator, calculate the amount of the annual rental payment and show calculations! (check figure = $28,718)

(c) Prepare all journal entries for Flynn for the period January 1, 2019 to January 1, 2020 under the assumption that the residual value is not guaranteed by the lessee.

(d) Repeat part (c) under the assumption that the residual value is guaranteed by the lessee.

(e) List three advantages of leasing arrangements.

Answer 1