Rauch Incorporated leases a piece of equipment to Donahue Corporation on January 1, 2020. 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 guaranteed. 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. Describe the nature of the lease to both Rauch and Donahue.

b. Prepare the lease amortization schedule(s) for Donahue for all 4 years of the lease.

c. Prepare the journal entries for Donahue for 2020 and 2021.

d. Suppose Donahue incurs initial direct costs of $750 related to the lease. Prepare the journal entries for 2020.

e. Explain how a fully guaranteed residual value by Donahue would change the accounting for the company. The expected residual value is $9,000.

f. 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 Donahue.