Bullwinkle Corp. leased medical equipment from Rocky Co., signing a lease agreem

Question

Bullwinkle Corp. leased medical equipment from Rocky Co., signing a lease agreement that stipulates annual payments of $250,000 on January 1 of each year for a five-year period. The first payment is due at the signing of the lease transaction on 1/1/17.

Rocky Co. set an implicit rate of 6% in the terms of the agreement, which is equal to the incremental borrowing rate of Bullwinkle Corp. Rocky has also stipulated a residual value of $400,000 at the end of the lease term. Bullwinkle is not required to guarantee it.

There is no transfer or ownership and the lease is noncancellable. The fair value of the leased equipment is $1,415,180 and the equipment cost Rocky Co. $800,000 to manufacture. It has a useful life of 10 years.

Classify the lease and provide evidence to substantiate your classification decision.

1. Provide journal entries for both lessee and lessor at the inception of the lease (1/1/17).

2. Provide journal entries to record the necessary adjustments at year-end, 12/31/17.

3. Provide journal entries to record the payment of cash on 1/1/17.

4. Provide new journal entries adjusting the lease contract on 12/31/17 if the $400,000 guaranteed residual value were set to $1,000,000 (assume all other information regarding the lease contract remains constant).

Explanation / Answer

The lease will be classified as Operating Lease:

Part1:

Workings:

Part 2:

Workings:

Part 3:

Part 4:

Workings:

In the Books of Lessee Date Account description Debit Credit 1-Jan Right to Use Assets      1,116,276 Lease Obligation          866,276 Cash          250,000 (Being Lease Recorded)

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