Reference no: EM132873215

Lessor Ltd. constructs and leases a new machine to Lessee Inc. Lessor appropriately treats the lease as a sales-type lease with an implicit interest rate of 8%. Prior to signing the lease agreement Lessor incurred $15 in labor cost negotiating the lease and another $5 was paid as a commission to a leasing agent who arranged the lease. Lessor's year end is December 31.

Terms of the lease agreement are as follows:

1. The lease term is 3 years, and begins on June 1, YR06.
2. Annual rental payments are $100 and are made on June 1 of each year (annuity present value=$279), starting June 1, YR06.
3. At the end of the lease term Lessee has the option to purchase the machine for $10 (present value=$8). At inception of the lease Lessor does not expect Lessee to exercise the purchase option.
4. The lease contains no automatic title transfer.
5. If Lessee does not exercise the purchase option the machine will be returned to Lessor. If the machine is returned to Lessor it is expected to have a fair value of $27 (present value=$21). Regarding this expected fair value, Lessee has guaranteed the value to be at least $20 (present value=$16), with the remaining amount of $7 (present value=$5) unguaranteed.

Facts about the machine include:

6. The machine cost Lessor $200 to manufacture.
7. At lease inception the fair market value of the machine is $300.
8. At lease inception the machine is expected to have a 4 year useful life.

Question 1. The sales revenue to be recorded by Lessor in YR06 related to this lease is (round to nearest dollar):

a. $279
b. $295
c. $300
d. $310
e. none of the above.

Question 2. The cost of goods sold to be recorded by Lessor in YR06 related to this lease is (round to nearest dollar):

a. $179
b. $184
c. $195
d. $200
e. none of the above.

Question 3. The interest income/revenue to be recorded by Lessor in YR06 related to this lease is (round to nearest dollar):

a. $8
b. $9
c. $14
d. $24
e. none of the above.

Question 4. How should the Lessor account for the $15 contract negotiation cost and the $5 leasing commission?

a. both of these costs should be expensed in YR06.
b. both of these costs should be capitalized and amortized to expense over the lease term.
c. the labor cost should be expensed in YR06 and the leasing commission cost should be capitalized and amortized to expense over the lease term.
d. both of these costs should be added to the net investment in the lease and amortized as a yield adjustment over the lease term.
e. none of the above.