Sage Industries and Pronghorn Inc. enter into an agreement that requires Pronghorn Inc. to build three diesel-electric engines to Sage's specifications. Upon completion of the engines, Sage has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is non-cancelable, becomes effective on January 1, 2020, and requires annual rental payments of $405,443 each January 1, starting January 1, 2020. Sage's incremental borrowing rate is 8%. The implicit interest rate used by Pronghorn and known to Sage is 7%. The total cost of building the three engines is $2,685,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Sage depreciates similar equipment on a straight-line basis. At the end of the lease, Sage assumes title to the engines. Collectibility of the lease payments is probable.

(a)

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Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor. The lease should be treated as a operating leasefinance leasesales-type lease by Sage Industries. The lease should be treated as a operating leasesales-type leasefinance lease by Pronghorn Inc.

(b), (c) and (d)

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(b) Prepare the journal entry to record the transaction on January 1, 2020, on the books of Sage (the lessee). (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.)

Account Titles and Explanation	Debit	Credit

(c) Prepare the journal entry to record the transaction on January 1, 2020, on the books of Pronghorn (the lessor). (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, 2020. (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, 2020)
Lessor (January 1, 2020)	Debit	Credit

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(e1)

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

SAGE INDUSTRIES/PRONGHORN INCORPORATED Lease Amortization Schedule
Date		Annual Lease Receipt/Payment		Interest on Receivable/Liability		Reduction in Receivable/Liability		Lease Receivable/ Liability
1/1/20		$		$		$		$
1/1/20
1/1/21
1/1/22

(e2)

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(f)

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(g)

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