*Problem 21-3 Culver Industries and Larkspur Inc. enter into an agreement that r

Question

*Problem 21-3 Culver Industries and Larkspur Inc. enter into an agreement that requires Larkspur Inc. to build three diesel-electric engines to Culver's specifications. Upon completion of the engines, Culver 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 $411,901 each January 1, starting January 1, 2017 Culver's incremental borrowing rate is 10%. The implicit interest rate used by Larkspur Inc. and known to Culver is 8% The total cost of building the three engines is $2,547,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Culver depreciates similar equipment on a straight-line basis. At the end of the lease Culver assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs Click here to view factor tables (b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Culver 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.) 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 Larkspur 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 O 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 O for the amounts.) Account Titles and Explanation Lessee (January 1, 2017) Debit Credit Lessor (January 1, 2017]) Debit Credit

Explanation / Answer

SOLUTION

Present value of lease payments-

$411,901 * 7.24689 = 2,985,000

*Present value of an annuity due at 8% for 10 years, rounded by $1.

Dealer profit

Journal entries-

Lease amortization schedule-

Journal entries-

Balance sheets-

Culver Industries

Balance sheet

Larkspur Inc.

Balance sheet

Sales (present value of lease payment) 2,985,000 Less: Cost of engines (2,547,000) Profit on sales 438,000

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