Reference no: EM13483727

On January 1, 2011 the XGX Company entered into a lease for equipment for use in its factory from the XGZ Leasing Company. The following information pertains to the lease:

Lease term: 6 years

• Equipment fair value at lease inception: $231,000
• XGZ Leasing Company's cost of the equipment: $196,000
• Equipment economic life: 7 years
• Unguaranteed residual value: $28,000
• XGZ Leasing Company's imputed rate of return: 3%
• XGX Company's incremental borrowing rate: 9%

Additional information:

• The lease is noncancelable.
• At the end of the lease term, the equipment reverts back to the XGZ Leasing Company and the lease contains no provision for renewal.
• The rental payments are due annually beginning on January 1, 2011 and on each January 1 thereafter for the term of the lease. The XGX Company depreciates all of its equipment using the straight-line method.
• The XGX Company is not aware of XGZ Leasing Company's imputed rate of return.
• The collection by XGZ Leasing Company of the rental payments is reasonably assured.
• There is no important uncertainty about the costs yet to be incurred by the GAB Leasing Company.
• Both the XGX Company and the GAB Leasing Company end their fiscal year on December 31.

Instructions:

A. Discuss the nature of this lease for the XGX Company. What accounting approach should the XGX Company utilize? Explain. B. Discuss the nature of this lease for the GAB Leasing Company. What accounting approach should the GAB Leasing Company utilize? Explain.

C. Compute the annual rental payment for this lease.

D. Prepare all of the necessary journal entries for the XGX Company for 2011.

E. Prepare all of the necessary journal entries for the GAB Leasing Company for 2011.