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Adams Corp capital lease nonguaranteed salvage test JEs

Hello, I need help or further elaboration on how to test perform the economic life test and the recovery of investment test. The recovery of investment test also has more criteria as listed below (after sample problem). If you can elaborate on these concepts, I would really appreciate it.


Criteria for capital lease (must meet one)
Transfer of ownership
Bargain purchase option
Economic life test (75%)
Recovery of investment test (90%)
Treat as operating lease if none of the above criteria are met

On January 1, 2014, Adams Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Adams to make annual payments of $9,968 at the beginning of each year, starting January 1, 2014. The machine has an estimated useful life of 6 years and a $5,000 unguaranteed residual value. Adams uses the straight-line method of depreciation for all of its plant assets. Adams's incremental borrowing rate is 10%, and the lessor's implicit rate is unknown

What type of lease is this? Explain.
Compute the present value of the minimum lease payments. (PV factor 4.16986)
Prepare all necessary journal entries for Adams for this lease through January 1, 2015

Minimum lease payments
Minimum rental payments
Guaranteed residual value
Penalty for failure to renew or extend the lease
Bargain purchase option
Executory costs
Discount rate

Solution Preview

The economic life test takes the lease term and compares it to the useful life of assets. If the lease term is 75% or more of the asset life, it is a capital lease. So, this is a ...

Solution Summary

See the computations for the PV of the minimum lease payments and the journal entries in the Excel file attached. The rule for economic life and investment recovery are explained.