Ludwick Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2020. Annual rental payments of $40,000 are to be made at the beginning of each lease year (December 31). The interest rate used by the lessor in setting the payment schedule is 6%; Ludwick’s incremental borrowing rate is 8%. Ludwick is unaware of the rate being used by the lessor. At the end of the lease, Ludwick has the option to buy the equipment for $5,000, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Ludwick uses the straight-line method of depreciation on similar owned equipment.

Instructions

a. Prepare the journal entry or entries, with explanations, that Ludwick should record on December 31, 2020.

b. Prepare the journal entry or entries, with explanations, that Ludwick should record on December 31, 2021. (Prepare the lease amortization schedule for all five payments.)

c. Prepare the journal entry or entries, with explanations, that Ludwick should record on December 31, 2022.

d. What amounts would appear on Ludwick’s December 31, 2022, balance sheet relative to the lease arrangement?