Luv Company enters into a non-cancelable lease agreement with Soap Company. The details of the agreement are as follows:
Inception date
Jan 1, 2011
Annual lease payment at beginning of each year, starting Jan 1, 2011
$18,000
Bargain-purchase option at the end of the lease
$4,000
Lease term
5 years
Economic life of leased equipment
5 years
Lessor’s cost
$60,000
Fair value of asset
$70,000
Lessor’s implicit rate
10%
Lessee’s implicit rate
10%
Present value of annuity due i=10%, n=5 periods
4.16987
Present value i=10%, n=5 years
0.621
Soap company will receive the lease payments. The collectability of the lease payments is reasonably predictable and there are no uncertainties surrounding the costs to be incurred by Soap company—the lessor.
For Luv company—the lessee—what is the nature of the lease? What tests does it meet?
For Soap company—the lessor—what is the nature of the lease?
Prepare the amortization schedule for Luv Company for the 5-year term.
Prepare the journal entries on the books of Luv company—the lessee—for recording the lease and the recording of lease payment and expenses for 2011.
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