Textbook Problem

Determining Type of Lease and Subsequent Accounting On January 1, 2019, Alice Company leases nonspecialized equipment for 5 years, agreeing to pay $65,000 annually at the beginning of each year under the noncancelable lease. Superior Equipment Company, the lessor, agrees to remit all executory costs, estimated to be $3,450 per year. The cost of the equipment is $275,000 and the fair value of the equipment is $305,000. Its estimated life is 10 years. The estimated residual value at the end of 5 years is $75,000 and is not guaranteed by Alice; at the end of 10 years, it is $5,000. There is no bargain purchase option in the lease or any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. On October 1 of each war, Superior Equipment pays property taxes of $650, maintenance costs of $1,600, and insurance of $1,200. Due to recent cash flow problems, Superior believes that Alice may not be able to make all of the required lease payments. Straight-line depreciation is considered the appropriate method by both companies.

Required:

1. 1. Next Level Identify the type of lease involved for Alice and Superior Equipment and give reasons for your classifications.
2. 2. Prepare appropriate journal entries for 2019 for the lessee and lessor.
3. 3. Next Level Assume that the residual value is guaranteed by Alice, and Alice believes the probable payment under this guarantee is $75,000. Identify the type of lease and briefly explain why. Assume the executory costs are included in the amount of the lease payments. Prepare journal entries for 2019 and 2020 for the lessee and lessor.