Salem Creamery (lessee) leases its ice cream making equipment from Big City Finance Company (lessor) under the following lease terms: 

■ The lease term is five years, non-cancellable, and requires equal rental payments of $46,498 first payable on the commencement date of the lease (January 1, 2019). 

■ On January 1, 2019, Big City purchased the equipment at its fair value of $200,100 and immediately transferred it to Salem Creamery. The equipment has an estimated economic life of five years and a $10,000 residual value that is guaranteed by Salem Creamery. Salem expects to pay out the entire $10,000 on the guarantee. 

■ The lease does not include a renewal option and the equipment reverts to Big City Finance Company upon termination of the lease. 

■ Salem’s incremental borrowing rate is 10%; the interest rate implicit in the lease is also 10%. 

■ Salem depreciates similar equipment that it owns on a straight-line basis. 

■ Both companies have December 31 year ends. 

Required:

a. Evaluate how the lessor (Big City) should account for the lease transaction. 

b. Prepare a lease amortization schedule for this lease for Salem Creamery, the lessee. 

c. Prepare the journal entries on January 1, 2019, December 31, 2019, and January 1, 2020, for Big City, the lessor.

d. Prepare the journal entries on January 1, 2019, December 31, 2019, and January 1, 2020, for Salem Creamery, the lessee. 

e. On December 31, 2023, the actual residual value of the equipment is $4,000. Salem returns the equipment to Big City and pays the required amount under the residual value guarantee. Prepare the journal entry for this final transaction on Salem’s books.