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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

$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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