Accounting for Leases

Teal Industries and Flint Inc. enter into an agreement that requires Flint Inc. to build three diesel-electric engines to Teal’s specifications. Upon completion of the engines, Teal 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 $384,165 each January 1, starting January 1, 2017.Teal’s incremental borrowing rate is 10%. The implicit interest rate used by Flint Inc. and known to Teal is 8%. The total cost of building the three engines is $2,395,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Teal depreciates similar equipment on a straight-line basis. At the end of the lease, Teal assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

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