On January 2, 2012, Austen Company contracted to lease a mainframe computer on a noncancelable basis for seven years at an annual rental of $85,200, payable at the end of each year. The computer has an estimated economic life of eight years. There is no bargain purchase option, and the computer will be returned to the lessor at the end of the seven-year term of the lease. At the beginning of the lease, the computer has a fair value of $445,000, and the present value of the lease payments equals $414,789.
Required:
1. Is this a capital lease or an operating lease? Explain.
2. Assuming that the lease is an operating lease, prepare the journal entries for Austen for 2012.
3. Assuming that the lease is a capital lease, prepare the journal entries for Austen for 2012. Assume the lease payment at the end of 2012 includes interest of $41,479.