On January 1, 2011, Cage Company contracts to lease equipment for 5 years, agreeing to make a

Question:

On January 1, 2011, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of $137,899 (including the executory costs of $6,000) at the beginning of each year, starting January 1, 2011. The taxes, the insurance, and the maintenance, estimated at $6,000 a year, are the obligations of the lessee. The leased equipment is to be capitalized at $550,000. The asset is to be depreciated on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 12%, and the implicit rate in the lease is 10%, which is known by Cage. Title to the equipment transfers to Cage when the lease expires, the asset has an estimated useful life of 5 years and no residual value. Instructions (Round all numbers to the nearest dollar.)

(a) Explain the probable relationship of the $550,000 amount to the lease arrangement.

(b) Prepare the journal entry or entries that should be recorded on January 1, 2011, by Cage Company.

(d) Prepare the journal entry to record the interest expense for the year 2011.

(e) Prepare the journal entry to record the lease payment of January 1, 2012, assuming reversing entries are not made.

(f) What amounts will appear on the lessee’s December 31, 2011, balance sheet relative to the lease contract?

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