Question

E21-7 (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2007, Bensen Company leased equipment to Flynn Corporation. The following information pertains to thislease.

1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts tothe lessor at the termination of the lease.

2. Equal rental payments are due on January 1 of each year, beginning in 2007.

3. The fair value of the equipment on January 1, 2007, is $150,000, and its cost is $120,000.

4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000.Flynn depreciates all of its equipment on a straight-line basis.

5. Bensen set the annual rental to ensure an 11% rate of return. Flynn’s incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.

6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.

Instructions
(Both the lessor and the lessee’s accounting period ends on December 31.)

(a) Discuss the nature of this lease to Bensen and Flynn.
(b) Calculate the amount of the annual rental payment.
(c) Prepare all the necessary journal entries for Flynn for 2007.
(d) Prepare all the necessary journal entries for Bensen for 2007.