Scuppermong Farms, the lessee, and Tyrrell Equipment, the lessor, sign a lease agreement on January 1, 2007 that provides for Scuppermong Farms to lease a cultivator from Tyrrell Equipment. The lease terms, provisions, and other related events are as follows: The lease is non-cancelable and has a term of six years. The annual rentals are $56,100, payable at the beginning of each year. Tyrrell Equipment agrees to pay all executory costs, which are expected to be $1,100 annually, including property taxes of $500, insurance of $350, and maintenance of $250.
Scuppermong Farms guarantees a residual value of $60,000 at the end of six years. The interest rate implicit in the lease is 14%, which is known by Scuppermong. Scuppermong Farms’ incremental borrowing rate is 15% and it uses the sum-of-the-years’-digits method to record depreciation on similar equipment.
The cost and fair value of the cultivator to Tyrrell Equipment is $271,154.68. The lessor incurs no material initial direct costs. The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor.
1. Identify the type of lease involved for both Scuppermong Farms and Tyrrell Equipment, and give reasons for your classifications.
2. Prepare the journal entries for both Scuppermong Farms and Tyrrell Equipment for 2007.
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