Reference no: EM132522663
Question - Apple Limited, a manufacturer of custom made production equipment, had entered into two lease agreements with the following entities: Equipment Alpha Apple Limited leased a highly specialized equipment (Equipment Alpha), with an estimated economic useful life of five years, to Orange Limited on 1 January 2019, such that only Orange Limited could use this equipment without any modification and installation. At the inception of the lease, the fair value of the equipment was $30,375. Details of the lease arrangement are listed as below:
Term of lease (non-cancellable) four years
Annual lease payment (every 31 Dec) $10,000
Ownership will be transferred to Orange Ltd at the end of the lease term. The manufacturing cost of the equipment for Apple Limited is $15,000
Machine Beta Apple Limited leased a machine (Machine Beta) from Grape Limited on 1 July 2019. The lease provisions required Apple Limited to pay three annual payments of $42,000 to Grape Limited beginning 1 July 2019. The expected economic life of the machine was six years. At the end of the lease, Apple Limited has to return the machine to Grape Limited. At the inception of the lease, the fair value of the machine was $150,000. Grape Limited purchased the machine at the cost of $120,000 in 2017.
The relevant interest rate implicit in both leases are 12% per annum. All the companies are adopting straight-line method for depreciation as at the year-end date on 31 December 2019.
Required: (Answers should be rounded to the nearest dollar)
(a) Determine and explain how Apple Limited should classify the lease for Equipment Alpha.
(b) Prepare the journal entries for both Apple Limited and Orange Limited to account for the lease mentioned in part (a) above, for the year ended 31 December 2019.
(c) Determine and explain how Apple Limited should classify the lease for Machine Beta.
(d) Prepare the journal entries for Grape Limited to account for the lease mentioned in part (c) above as at the year-end date on 31 December 2019.