On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The fo

Question

On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The following information pertains to this lease. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.

Equal rental payments are due on January 1 of each year, beginning in 2011.

The fair value of the equipment on January 1, 2011, is $200,000, and its cost is $150,000.

The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Woods depreciates all of it equipment on a straight-line basis.

Palmer sets the annual rental to ensure an 11% rate of return. Woods’ incremental borrowing rate is 12%. The implicit rate of the lessor is not known to Woods.

Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor.

REQUIRED:

a) Discuss the nature of this lease to Woods.

b) Prepare all the necessary journal entries for Woods through January 1, 2012.

c) Discuss the nature of this lease to Palmer.

d) If the cost of this lease had been $200,000, how with this have changed your answer to Part (c)?

e) Had the title of the lease transferred at the end of the lease, how with this have changed your depreciation calculation for Woods?

Explanation / Answer

it covers major life of asset so it is financial lease.

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