Problem 21-3

Indigo Industries and Sweet Inc. enter into an agreement that requires Sweet Inc. to build three diesel-electric engines to Indigos 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. Indigos 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.)