Lessor enters into an 8-year lease of equipment with Lessee…

Lessor enters into an 8-year lease of equipment with Lessee. Lessor sells and leases the equipment,
which is not specialized in nature and is expected to have alternative use to Lessor at the end of the
lease term. Under the lease:
− Lessor receives annual lease payments of $25,000, payable at the end of the first year of the
lease and annually at the lease anniversary date thereafter.
− Lessor expects the residual value of the equipment to be $130,000 at the end of the 8-year lease
term.
− Lessor obtains an RVG from an unrelated third party other than Lessee that protects Lessor for
the first $100,000 of loss below the estimated residual value of $130,000.
− The equipment has an estimated remaining economic life of 15 years, a carrying amount of
$170,000 and a fair value of $180,000.
− The lease does not transfer ownership of the underlying asset to Lessee at the end of the lease
term or contain an option for Lessee to purchase the underlying asset.
− The rate implicit in the lease is 11.597%.
At lease commencement, Lessor concludes that it is probable that it will collect the lease payments
and any amount owed under the RVG provided by the third party.

► How should Lessor classify this lease?
► Prepare the journal entries at the time of the lease commencement and for Year 1 of the lease
term.