Lu Limited is expanding and needs more manufacturing equipment. The company has been offered a lease contract for equipment with a fair value of $116,000. The lease has a five-year term, end of year payment renewable for a further two years at the option of the lessee. Annual rental for the first term is $28,600, for the second, $11,500. Payments are made each 31 December. The first term rental includes $2,600 for maintenance and insurance, the second, $1,500. Lease payments are close to market lease rates for both the first and second terms. At the end of the second term, Lu can buy the asset for $1. The machinery has an expected life of 10 years. Lu Limited has an incremental borrowing rate of 10%. Lu has been told that the interest rate implicit in Lease 1 is 8%.
Required:
Prepare an amortization table for the lease.
Assume that the lease was entered into on 1 January 20X2. Lu has a 31 December fiscal year-end. Prepare journal entries for the lease for 20X2, including any entries relating to the asset.
Prepare the entry to record exercise of the bargain purchase option.