Question

Crane Incorporated leases a piece of machinery to Blue Company on January 1, 2020, under the following terms.

1.		The lease is to be for 4 years with rental payments of $13,046 to be made at the beginning of each year.
2.		The machinery’ has a fair value of $68,934, a book value of $51,440, and an economic life of 10 years.
3.		At the end of the lease term, both parties expect the machinery to have a residual value of $25,720. To protect against a large loss, Crane requests Blue to guarantee $18,040 of the residual value, which Irving agrees to do.
4.		The lease does not transfer ownership at the end of the lease term, does not have any bargain purchase options, and the asset is not of a specialized nature.
5.		The implicit rate is 5%, which is known by Blue.
6.		Collectibility of the payments is probable.

Evaluate the criteria for classification of the lease, and describe the nature of the lease.

Prepare the journal entries for Blue for the year 2020.

Prepare the journal entries for Crane for the year 2020.

Suppose Blue did not guarantee any amount of the expected residual value. Prepare the journal entries for Blue for the year 2020.

Suppose Blue did not guarantee any amount of the expected residual value. Prepare the journal entries for Crane for the year 2020.

Answer 1

For Lessee, the lease shall be classified as Operating Lease.

Reason-
1. The asset reverts back to the lessor at the end of lease term.
2. There is no purchase option at the end of the lease term.
3. The asset is not leased for substantial period of economic life of asset.
4. The present value of minimum lease payments is not approximating to the fair value of the asset.

For Lessor

The present value of minimum lease payments approximates the fair value of asset.
Hence, the lease shall be classified as finance lease to the lessor.

The expected residual value of the asset, whether guaranteed or not, shall be considered in the minimum lease payments for the lessor.

When the residual value is not guaranteed by the lessee, the lessee shall not include any amount of residual value in recognizing the right to use value of the asset.

The journal entries shall be-

When the residual value is not guaranteed by the lessee, than there would be no change in entries for the lessor in the year 2020.

Reason-
For lessor, all the expected residual value has been considered irrespective of whether guaranteed by the lessee or not.

Hence, there is no change in the books of lessor.