Cleveland Inc. leased a new crane to Abriendo Construction under a 5-year non-cancelable contract starting January 1, 2011. Terms of the lease require payments of $33,000 each January 1, starting January 1, 2011. Cleveland will pay insurance, taxes, and maintenance charges on the crane, which has an estimated life of 12 years, a fair value of $240,000, and a cost to Cleveland of $240,000. The estimated fair value of the crane is expected to be $45,000 at the end of the lease term. No bargain-purchase or renewal options are included in the contract. Both Cleveland and Abriendo adjust and close books annually at December 31. Collectibility of the lease payments is reasonably certain, and no uncertainties exist relative to un-reimbursable lessor costs. Abriendo’s incremental borrowing rate is 10%, and Cleveland’s implicit interest rate of 9% is known to Abriendo.
(a) Identify the type of lease involved and give reasons for your classification. Discuss the accounting treatment that should be applied by both the lessee and the lessor.
(b) Prepare all the entries related to the lease contract and leased asset for the year 2011 for the lessee and lessor, assuming the following amounts.
(1) Insurance $500.
(2) Taxes $2,000.
(3) Maintenance $650.
(4) Straight-line depreciation and salvage value $15,000.
(c) Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2011?