Question - Lessee Company on January 1, 2010, enters into a 6-year non cancelable lease, with two renewal options of one year each, for equipment having an estimated useful life of 10 years. Lessee's incremental borrowing rate is 10%. Lessee uses the straight-line method to depreciate its assets. The lease contains the following provisions:

1. Rental payments of $80,000 including $8,000 for property taxes, payable at the beginning of each six month period.

2. The termination penalty assuring renewal of the lease for a period of two years after expiration of the initial lease term.

3. There is a bargain purchase option at the end of the lease for $40,000.

Collectibility of lease payments is reasonably predictable andno important uncertainties surround the amount of costs yet to be incurred by the lessor.

INSTRUCTIONS:

(a) What kind of lease is this to the lessee and lessor? What should be considered the lease term?

(b) What journal entries woud lessee and lessor record during the first year of the lease? (Include an amortization schedule through 1/1/2011)

(c) What journal entries would lessee and lessor record respectively at the end of the lease when the option is exercised?

(d) What journal entries would lessee and lessor record respectively at the end of the lease if the option is NOT exercised?