On January 1, 2019, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.

QUESTION:

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On January 1, 2019, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.

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1. The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equipment for $1,000, while the expected residual value at the end of the lease is $5,000.

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2. Equal rental payments are due on January 1 of each year, beginning in 2019.

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3. The fair value of the equipment on January 1, 2019, is $150,000, and its cost is $120,000.

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4. The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.

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5. Bensen set the annual rental to ensure a 5% rate of return. Flynn’s incremental borrowing rate is 6%, and the implicit rate of the lessor is unknown.

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6. Collectibility of lease payments by the lessor is probable.

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Instructions:

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(Both the lessor and the lessee’s accounting periods ending on December 31.)

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(a) Discuss the nature of this lease to Bensen.

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(b) Calculate the amount of the annual rental payment.

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(c) Prepare all the necessary journal entries for Bensen for 2019.

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(d) Suppose the collectibility of the lease payments was not probable for Bensen. Prepare all necessary journal entries for the company in 2019.

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(e) Prepare all the necessary journal entries for Flynn for 2019.

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(f) Discuss the effect on the journal entry for Flynn at lease commencement, assuming initial direct costs of $2,000 are incurred by Flynn to negotiate the lease.

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