Royals Incorporated leases a piece of equipment to Polar Corporation on January 1, 2020. The lease agreement called for annual rental payments of $8,648 at the beginning of each year of the 3-year lease. The equipment has a fair value of $35,000, a book value of $20,000, and an economic useful life of 5 years after which the residual value will be zero. Both parties expect a residual value of $12,500 at the end of the lease term, though this amount is not guaranteed. Royals set the lease payments with the intent of earning a 6% return, and Polar 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:

(Round all numbers to the nearest dollar.)

(a) Describe the nature of the lease to both Royals and Polar.

(b) Prepare the lease amortization schedule(s) for Polar for all 3 years of the lease.

(c) Prepare the journal entries for Polar for 2020 and 2021.