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Problem 21-3 Indigo Industries and Sweet Inc. enter into an agreement that requires Sweet Inc. to...

Problem 21-3

Indigo Industries and Sweet Inc. enter into an agreement that requires Sweet Inc. to build three diesel-electric engines to Indigo’s specifications. Upon completion of the engines, Indigo 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 $403,580 each January 1, starting January 1, 2017.

Indigo’s incremental borrowing rate is 9%. The implicit interest rate used by Sweet Inc. and known to Indigo is 7%. The total cost of building the three engines is $2,637,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Indigo depreciates similar equipment on a straight-line basis. At the end of the lease, Indigo assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

(b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Indigo 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 0 for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.)

(c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Sweet 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 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.)

(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017. (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 0 for the amounts.)

(e) Prepare a lease amortization schedule for 2 years. (Round answers to 0 decimal places e.g. 58,971.)

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Answer #1

Answer:

A B A*B
Present Value of Lease Payments                       4,03,580 7.51523 30,32,997
Sales                     30,32,997
Less: Cost of goods sold                     26,37,000
Profit on sale                       3,95,997
*Present value of an annuity due at 7% for 10 years.
Qb. Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Indigo Industries.
Date Account Title Debit($) Credit($)
Leased Engines (Capital Lease)        30,32,997
            Lease lability 30,32,997
(To record lease agrrement)
Qc. Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Sweet Inc.
Date Account Title Debit($) Credit($)
Lease receivable        30,32,997
Cost of goods sold        26,37,000
               Sales 30,32,997
               Inventory 26,37,000
Qd. Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.
Lessee
Date Account Title Debit($) Credit($)
Lease lability           4,03,580
          Cash     4,03,580
(To record rental payment in cash)
Lessor
Date Account Title Debit($) Credit($)
Cash           4,03,580
        Lease receivable     4,03,580
(To record rental receipt)
e) LEASE AMORTIZATION SCHEDULE:
Annual Interest Reduction
Date lease rent 7% Lease
01-01-2017 30,32,997
01-01-2017      4,03,580 0           4,03,580 26,29,417
01-01-2018      4,03,580 184059.2           2,19,521 24,09,896
01-01-2019      4,03,580 168692.7           2,34,887 21,75,008
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