Question

Cullumber Industries and Riverbed Inc. enter into an agreement that requires Riverbed Inc. to build three diesel-electric engines to Cullumber’s specifications. Upon completion of the engines, Cullumber 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 $395,894 each January 1, starting January 1, 2017. Cullumber’s incremental borrowing rate is 9%. The implicit interest rate used by Riverbed Inc. and known to Cullumber is 8%. The total cost of building the three engines is $2,443,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Cullumber depreciates similar equipment on a straight-line basis. At the end of the lease, Cullumber assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Cullumber Industries.

Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Riverbed Inc.

Answer 1

Ans. This is type of Capital Lease because lease period full life of Engines

Step: 1 Calculation of PV of Lease payment

lease payment is 395894 payment to be made 1 Jan every month means first payment to be made at the starting of lease remaining period of lease payment is 9years

Annunity Factor for First year            = 1

Annunity factor for 9yrs @8%           = 6.2469

Present value of lease payment = 395894X1+395894X6.2469 = 2869004

Step 2: Journal entry

                                 Journal Entry in the books of Cullumber industries (leasee)

Jan 1 2017                     Diesel Electric Engine (Assets) A/c Dr      2869004

                                                To Riverbed Inc. (lessor) A/c Cr.                         2869004

                   (Being Assets taken on lease from Riverbed inc.)

                     Jounral Entry in the books of Lessor or int the books Riverbed Inc.

Jan 1 2017                   Cullumber industries (lease Receivable) A/c Dr. 2869004

                                                       To Diesel Electric Engine(Assets) A/c Cr.          2869004

       (Recording the Diesel Electric Engine given to lease to cullumber, profit entry done seprately)