Question

Macinski Leasing Company Leases a new machine to Sharrer Corporation. The machine has a cost of $70,000 and fair value of $95,000. Under the 3 year, non-cancelable contract, Sharrer will receive title to the machine at the end of the lease. The machine has a 3 year useful life and no residual value. The lease was signed on January 1, 2017. Macinski expects to earn an 8% return on its investment, and this implicit rate is known by Sharrer. The annual rentals are payable on each December 31, beginning December 31, 2017.

a) Discuss the nature of the lease agreement and the accounting method that each party to the lease should apply

b) Prepare amortization schedule suitable for both the lessor and lessee

c) Prepare the journal entry at commencement of the lease for Macinski

d) Prepare the journal entry at commencement of the lease for Sharrer

e) Prepare the journal entry at commencement of the lease for Sharrer, assuming (1) Sharrer does not know Macinski's implicit rate (Sharrer's incremental borrowing rate is 9%), and (2) Sharrer incurs initial direct costs of $10,000.

Answer 1

a) Nature of Lease Agreement:

For Lessee:

The lease is a capital lease as the ownership is being transferred to lessee after lease period and the leased asset is with the lessee for its entire life.

For Lessor:

The lease is capital lease for the lessor, as it qualifies all the three conditions that is, capital lease for lessee, certainity of unreimburseable costs and collectability of lease payments from the lessee.

b) Amortization Schedule for both lessor and lessee is as follows:

c) Journal entry at the commencement of lease for Lessor (Macinski) is as follows:

d) Journal entry at the commencement of the lease to the Lessee (Sharrer) is as follows: