Assignment:
You are the new assistant controller for Supreme Sports Performance and Training (SSPT), Inc. SSPT just leased a new copier from Zeros Corporation, and the terms of the lease are:
The lease was signed on January 2 of the current year.
The lease cannot be cancelled.
The cost and fair value of the copier is $30,325.
The lease term is five years, which is also the useful life of the copier, and payments of $8,000 are to be made at the end of each year. There is no renewal option or bargain purchase option. Both SSPT and Zeros use straight-line depreciation.
The interest rate used by Zeros to compute the payments is stated in the lease agreement as 10%.
Residual value is unguaranteed and estimated at $2,000.
The lessee will pay executor costs of $200 per year.
The last time SSPT tried to get a loan, the company received a quote for an interest rate of 18%. The company has been shaky financially for the past two years and has missed some payments on loans. There have even been rumors that the company may not be around in a couple of years.
The copier will go back to Zeros at the end of the lease.
As you finish looking over the copier lease, Mr. Kahn, your boss, stops by your office.
"I see you're looking at the copier lease. So, how do you think we should account for it?" he asks.
"I just reviewed lease accounting before I took the Certified Public Accountant (CPA) exam," you reply. "I'm sure it's a capital lease."
"That can't be right!" your boss exclaims. "The agreement specifically says that Zeros will account for the lease as an operating lease. That means they will still show it as their asset. If we report it as a capital lease, we'll be showing it as an asset, too! You'd better go back and check. Write me a memo when you are sure about what we should do."
Based on your analysis of the information provided, answer the following questions:
How should the lease be classified for SSPT? Why?
How will Zeros classify the lease? Why?
Are there any journal entries needed for the first two years for SSPT? Why or why not? If yes, what journal entries are needed? If not, why are they not needed?
How will the lease be reported in the financial statements for both SSPT and Zeros?
Are there any disclosures required for SSPT? Why or why not?
Create the required journal entries in a Microsoft Excel spreadsheet. Use the spreadsheet to present your analysis as well.