On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The following information pertains to this lease.
- The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
- Equal rental payments are due on January 1 of each year, beginning in 2011.
- The fair value of the equipment on January 1, 2011, is $200,000, and its cost is $150,000.
- The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Woods depreciates all of its equipment on a straight-line basis.
- Palmer set the annual rental to ensure an 11% rate of return. Woods's incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
- Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
Instructions
(a) Answer the following questions.
- What type of lease is recorded by Palmer
- What type of lease is recorded by Woods?
(b) Calculate the amount of the annual rental payment.
(c) Prepare all the necessary journal entries for Woods for 2011.