Problem 21-3 Indigo Industries and Sweet Inc. enter into an agreement that requi
ID: 2528491 • Letter: P
Question
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 $399,557 each January 1, starting January 1, 2017.
Indigo’s incremental borrowing rate is 10%. The implicit interest rate used by Sweet Inc. and known to Indigo is 9%. The total cost of building the three engines is $2,371,000. 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.
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Account Titles and Explanation
Debit
Credit
Account Titles and Explanation
Debit
Credit
Account Titles and Explanation
Debit
Credit
Lessee (January 1, 2017)
Lessor (January 1, 2017)
Debit
Credit
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 $399,557 each January 1, starting January 1, 2017.
Indigo’s incremental borrowing rate is 10%. The implicit interest rate used by Sweet Inc. and known to Indigo is 9%. The total cost of building the three engines is $2,371,000. 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.
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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 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.)
Account Titles and Explanation
Debit
Credit
(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.)
Account Titles and Explanation
Debit
Credit
Lessee (January 1, 2017)
Lessor (January 1, 2017)
Debit
Credit
Explanation / Answer
b) in the Books of Indigo Industries
On receipt of Lease Rent on 1 Jan 2017
Sweet Inc a/c Dr $399557
To Lease Rental Receivable a/c Cr $399557
On Payment of Borrowing cost as on 31 Dec 2017
Interest on Borrowing a/c Dr $237100
To Interest Payble a/c Cr $237100
On transfer of lease rent to p&l a/c as on 31 Dec 2017
Lease Rental Receivable A/c Dr $399557
To Profit & Loss A/c $399557
On Transfer of Interest cost to P& L A/c
P& L A/c Dr $237100
To Interest on Borrowing $237100
c) Journal Entries on the Books of Sweet Inc
On payment of Lease rental on 1 Jan 2017
Lease Rental A/c Dr $399557
To Indigo Ind $399557
Depriciation Charges on 31 Dec 2017
Depriciaiton A/c Dr $ 237100
To Engine a/c $ 237100
Lease Rent Transfer in P& L A/c
P&L A/c Dr $399557
To Lease Rent Paind $399557
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