Question - Merlin Co. leased equipment to Houdini Inc. The equipment cost the lessor $200,000. The appropriate interest rate for this lease is 15%. The annual lease payments are made at the end of each year. The lease term is 3 years. The residual value at the end of the lease term is expected to be $40,000. Houdini has the option to purchase the equipment at that time for $20,000. Assume this is a direct financing lease.

Required:

1. For this lease:

(a) The lease payment computed by the lessor is $_____________

(b) The amount the lessee should capitalize is $____________

2. How much interest should be recognized at the end of year 1 by the:

(a) Lessor?

(b) Lessee?