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P Company enters into a lease agreement with L Co. on Jan...

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Accounting

P Company enters into a lease agreement with L Co. on Jan 1,1998, to lease a machine to be used
in its manufacturing operations. The following data pertain to this agreement.
a. The term of the noncancelable lease is 5 years, with no residual value at the end of the lease term.
Payments of $18,142.95 are due on Jan. 1 of each year. The first payment in advance is paid on
Jan. 1,1998.
b. The fair value of the machine on Jan 1,1996 is $80,000. The machine has an economic life of 5 years,
with salvage value of $7,000 none of which is guaranteed. The machine reverts to the lessor upon the
termination of the lease.
c. P pays executory costs of $900 to Rock Insurance Co. and $1,600 to County for property taxes.
d. P's incremental borrowing rate is 12% and the lessor's is 10% and is known to lessee.
Is this a capital lease or operating lease. Why?
Instructions: Prepare journal entries on the books of the lessee through the first two years of lease.
The accounting period of P and L Company ends on December 31.
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