Oriole Industries and Waterway Inc. enter into an agreement that requires Waterway Inc. to build three diesel-electric engines to Oriole’s specifications. Upon completion of the engines, Oriole 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 $362,863 each January 1, starting January 1, 2020. Oriole’s incremental borrowing rate is 8%. The implicit interest rate used by Waterway and known to Oriole is 7%. The total cost of building the three engines is $2,358,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Oriole depreciates similar equipment on a straight-line basis. At the end of the lease, Oriole assumes title to the engines. Collectibility of the lease payments is probable.
Oriole Industries and Waterway Inc. enter into an agreement that requires Waterway Inc. to build three diesel-electric engines to Oriole’s specifications. Upon completion of the engines, Oriole 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 $362,863 each January 1, starting January 1, 2020. Oriole’s incremental borrowing rate is 8%. The implicit interest rate used by Waterway and known to Oriole is 7%. The total cost of building the three engines is $2,358,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Oriole depreciates similar equipment on a straight-line basis. At the end of the lease, Oriole assumes title to the engines. Collectibility of the lease payments is probable.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
Oriole Industries and Waterway Inc. enter into an agreement that requires Waterway Inc. to build three diesel-electric engines to Oriole’s specifications. Upon completion of the engines, Oriole 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 $362,863 each January 1, starting January 1, 2020.
Oriole’s incremental borrowing rate is 8%. The implicit interest rate used by Waterway and known to Oriole is 7%. The total cost of building the three engines is $2,358,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Orioledepreciates similar equipment on a straight-line basis. At the end of the lease, Oriole assumes title to the engines. Collectibility of the lease payments is probable.
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Oriole’s incremental borrowing rate is 8%. The implicit interest rate used by Waterway and known to Oriole is 7%. The total cost of building the three engines is $2,358,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Oriole
Click here to view factor tables.
https://education.wiley.com/content/Kieso_Intermediate_Accounting_17e/media/simulations/interest_rate_tables.pdf
(a)
Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.
The lease should be treated as a
The lease should be treated as a
by Oriole Industries.
The lease should be treated as a
by Waterway Inc.
(b), (c) and (d)
(b) Prepare the journal entry to record the transaction on January 1, 2020, on the books of Oriole (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.)
(c) Prepare the journal entry to record the transaction on January 1, 2020, on the books of Waterway (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.)
(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.)
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Account Titles and Explanation
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Debit
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Credit
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(c) Prepare the journal entry to record the transaction on January 1, 2020, on the books of Waterway (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.)
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Account Titles and Explanation
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Debit
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Credit
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(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.)
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Account Titles and Explanation
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Debit
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Credit
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Lessee (January 1, 2020)
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Lessor (January 1, 2020)
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Debit
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Credit
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(e1)
Prepare a lease amortization schedule for 2 years. (Round answers to 0 decimal places e.g. 58,971.)
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ORIOLE INDUSTRIES/WATERWAY INCORPORATED
Lease Amortization Schedule |
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Date
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Annual Lease
Receipt/Payment |
Interest on
Receivable/Liability |
Reduction in
Receivable/Liability |
Lease
Receivable/ Liability |
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| 1/1/20 | $ | $ | $ | $ | ||||
| 1/1/20 | ||||||||
| 1/1/21 | ||||||||
| 1/1/22 |
(e2)
Prepare the journal entries for both the lessee and lessor to record any entries needed in connection with the lease at December 31, 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.)
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Account Titles and Explanation
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Debit
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Credit
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Lessee (December 31, 2020)
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| (To record interest) | ||
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| (To record amortization) | ||
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Lessor (December 31, 2020)
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Debit
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Credit
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(f)
Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2020, for both the lessee and the lessor.
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ORIOLE INDUSTRIES
Balance Sheet (Partial) |
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Asset
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$
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Current Liability
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$
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WATERWAY INC.
Balance Sheet (Partial) |
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Assets
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$
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$
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(g)
Assume that Oriole incurs legal fees related to the execution of the lease of $30,000. In addition, assume Oriole receives a lease incentive from Waterway of $50,000 to enter the lease. How will this affect your answer to part b?
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Account Titles and Explanation
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Debit
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Credit
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