Question

On January 1, 2018 WAG entered into a non-cancellable lease agreement with PE for the lease of specialized laboratory equipment designed to draw blood to perform health tests for their customers. The lease agreement requires WAG to make beginning of the year payments for the 5-year term of the lease. The fair value of the equipment at lease inception is $25,418,156. WAG guarantees to PE that the residual value of the equipment at the end of the term of the lease will be $2,500,000. However, given that the equipment is heavily used by WAG it has an expected residual value at the end of the lease of $2,250,000.

The useful life of the equipment is 10 years with a salvage value to PE of $2,500,000. Both PE and WAG use the straight-line method of depreciation (or amortization) for their equipment and right of use assets. The lease contract includes a written option that would give WAG the option to purchase the underlying equipment for a price of $3,500,000.

Collectability of lease payments is reasonably predictable.

PE's implicit rate of return of 8% is known to WAG and WAG's incremental borrowing rate is 10%.

1) What would be the amount to be recovered by the lessor (PE) through equal lease payments?

2) From the perspective of the lessee, which criteria for classifying a lease as a finance lease were met?

3) What would be the journal entry that WAG needs to post to their general ledger to recognize the lease inception and first payment on January 1, 2019?

4) Amortization expense recorded by WAG in each year would be calculated as:

Answer 1