On January 1, 2025, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of $120,987 at the beginning of each year, starting January 1, 2025. The leased equipment is to be capitalized at $550,000. The asset is to be amortized on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 6%, and the implicit rate in the lease is 5%, which is known by Cage. Title to the equipment transfers to Cage at the end of the lease. The asset has an estimated useful life of 5 years and no residual value.

Instructions

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

b. Prepare the journal entry or entries that Cage should record on January 1, 2025.

c. Prepare the journal entries to record amortization of the leased asset and interest expense for the year 2025.

d. Prepare the journal entry to record the lease payment of January 1, 2026, assuming reversing entries are not made.

e. What amounts will appear on the lessee’s December 31, 2025, balance sheet relative to the lease contract?

f. How would the value of the lease liability in part b change if Cage also agreed to pay the fixed annual insurance on the equipment of $2,000 at the same time as the rental payments?