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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


Bargain-purchase option at the end of the lease


Lease term

5 years

Economic life of leased equipment

5 years

Lessor’s cost


Fair value of asset


Lessor’s implicit rate


Lessee’s implicit rate


Present value of annuity due i=10%, n=5 periods


Present value i=10%, n=5 years



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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