(Accounting for an Operating Lease)

Rauch Incorporated leases a piece of equipment to Donahue Corporation on January 1, 2017. The lease agreement called for annual rental payments of $4,892 at the beginning of each year of the 4-year lease. The equipment has an economic useful life of 6 years, a fair value of $25,000, a book value of $20,000, and both parties expect a residual value of $8,250 at the end of the lease term, though this amount is not guaran-

teed. Rauch set the lease payments with the intent of earning a 5% return, and Donahue is aware of this rate. There is no

bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a

specialized nature

Instructions

(a)

Explain (and show calculations) how Rauch arrived at the amount of the rental payments used in the lease agreement.

(b)

Prepare the entries for Rauch for 2017.

(c)

Suppose that instead of $8,250, Rauch expects the residual value at the end of the lease to be $5,000, but Donahue agrees

to guarantee a residual value of $8,250. All other facts being equal, how would Rauch change the amount of the annual

rental payments, if at all?

(d)

Explain how a fully guaranteed residual value by Donahue would change the accounting for Rauch, the lessor.

(e)

Explain how a bargain renewal option for one extra year at the end of the lease term would change the accounting of

the lease for Rauch, the lessor.