Question

Problem 21-3 Cheyenne Industries and Ayayai Inc. enter into an agreement that requires Ayayai Inc. to build three diesel-electric engines to Cheyenne's specifications. Upon completion of the engines, Cheyenne has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of $445,159 each January 1, starting January 1, 2017. Cheyenne's incremental borrowing rate is 10%. The implicit interest rate used by Ayayai Inc. and known to Cheyenne is 9%. The total cost of building the three engines is $2,713,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Cheyenne depreciates similar equipment on a straight-line basis. At the end of the lease, Cheyenne assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs. Click here to view factor tables (b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Cheyenne Industries. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter o for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to O decimal places e.g. 58,971.) Account Titles and Explanation Debit Credit (c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Ayayai Inc. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter o for the amounts. Round answers to O decimal places e.g. 58,971.) Account Titles and Explanation Debit Credit

Answer 1

Requirement (a) Calculating the fair value of the equipment Since, the lesee is aware of implicit rate used by lessor, the lessor's implicit rate, i.e., 9% shall be used to discount the lease. Annual fixed lease payments 1+PVA(9%, 9 yrs) PV of Annual lease payments (445159*6.9952) Fair Value of the equipment 4,45,159 6.9952 31,13,976 $ 31,13,976 Requirement (b) (in $) Credit In the Books of Cheyenne Industries (Lessee) Journal (in $) Date Accounts Titles and Explanations Debit 01-Jan-17 Equipment 31,13,976 Lease Payable (To record entering into finance lease agreement) 31,13,976 Requirement (C) (in $) Credit In the Books of Ayayai Inc. (Lessor) Journal (in $) Date Accounts Titles and Explanations Debit 01-Jan-17 Lease Receivable 31,13,976 Sales (To record entering into finance lease agreement) 31,13,976 27,13,000 01-Jan-17 Cost of Goods sold Inventory (To record cost of goods sold) 27,13,000

Requirement (d) (in $) Debit (in $) Credit Date Journal Accounts Titles and Explanations Lessee Lease Payable Cash (To record entering payment of lease rental) 01-Jan-17 4,45,159 4,45,159 01-Jan-17 4,45,159 Lessor Cash Lease Receivable |(To record entering receipt of lease rental) 4,45,159 Requirement (e) Date Cheyenne Industries Lease Ammortization Schedule Interest on Reduction in Lease Annual lease receipt/payment Receivable/Liability Receivable/Liability Receivable/Liability 31,13,976 4,45,159 $ - $ 4,45,159 $ 26,68,817 4,45,159 $ 2,40,194 $ 2,04,965 24,63,852 4,45,159 $ 2,21,747 $ 2,23,412 $ 22,40,440 01-01-2017 01-01-2017 01-01-2018 01-01-2019 $ $ $

Requirement (1) (in $) Debit (in $) Credit Journal Date Accounts Titles and Explanations Lessee 31-Dec-17 Interest expense Lease Payable (To record interest expense for the year) 2,40,194 2,40,194 Lessor 31-Dec-17 Lease Receivable Interest income (To record interest income for the year) 2,40,194 2,40,194 Requirement (g) Cheyenne Industries Balance Sheet (Partial) As on December 31, 2017 Asset Non-Current Asset Equipment (-) Accumulated Depreciation Equipment 31,13,976 -3,11,398 28,02,578 Current Liability Lease Payable $ 26,68,817 Ayayai Inc Balance Sheet (Partial) As on December 31, 2017 Asset Current Asset Lease Receivable $ 26,68,817