Question

On January 1, 2020, Sandhill Company leased equipment to Flynn Corporation. The following information pertains to this lease.

1.		The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equipment for $2,000, while the expected residual value at the end of the lease is $5,000.
2.		Equal rental payments are due on January 1 of each year, beginning in 2020.
3.		The fair value of the equipment on January 1, 2020, is $170,000, and its cost is $140,000.
4.		The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.
5.		Sandhill set the annual rental to ensure a 7% rate of return. Flynn’s incremental borrowing rate is 8%, and the implicit rate of the lessor is unknown.
6.		Collectibility of lease payments by the lessor is probable.

Both the lessor and the lessee’s accounting periods end on December 31.

Prepare the effect on the journal entry for Flynn at lease commencement, assuming initial direct costs of $2,000 are incurred by Flynn to negotiate the lease.

Answer 1