Question - The following facts pertain to a noncancelable lease agreement between Shel Company, a lessor and Fal Company, a lessee.
Inception date: 5/1/x1
Annual lease payment on May 1, beginning with 5/1/x1 $20,987.83
Bargain purchase option at the end of lease term $4,000.00
Lease term 5 years
Economic life of equipment 10 years
Lessor's cost $65,000.00
Fair value of asset at 5/1/x1 $90,000.00
Lessor's implicit rate 10%
Lessee's incremental borrowing rate 10%
The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs. Both companies use the straight-line depreciation method.
a) Discuss the nature of this lease to Fal Company. What kind of lease and why?
b) Discuss the nature of this lease to Shel Company. What kind of lease and why?
c) Prepare the journal entries on the lessor's books to reflect the signing of the lease agreement and to record the receipts and income related to this lease for the years 20x1 and 20x2. Shel's annual accounting period ends on December 31.