Reference no: EM131777663

Problem - On January 1, 2011, Foley Company (as lessor) entered into a noncancelable lease agreement with Pinkley Company for machinery which was carried on the accounting records of Foley at $4,530,000 and had a market value of $4,800,000. Minimum lease payments under the lease agreement which expires on December 31, 2020, total $7,100,000. Payments of $710,000 are due each January 1. The first payment was made on January 1, 2011 when the lease agreement was finalized. The interest rate of 10% which was stipulated in the lease agreement is the implicit rate set by the lessor. The effective interest method of amortization is being used. Pinkley expects the machine to have a ten-year life with no salvage value, and be depreciated on a straight-line basis. Collectibility of the rentals is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions:

a. From the lessee's viewpoint, what kind of lease is the above agreement? From the lessor's viewpoint, what kind of lease is the above agreement?

b. What should be the income before income taxes derived by Foley from the lease for the year ended December 31, 2011?

c. Ignoring income taxes, what should be the expenses incurred by Pinkley from this lease for the year ended December 31, 2011?

d. What journal entries should be recorded by Pinkley Company on January 1, 2011?

e. What journal entries should be recorded by Foley Company on January 1, 2011?