Problem 21-3 Winston Industries and Ewing Inc. enter into an agreement that requ

Question

Problem 21-3 Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston's specifications. Upon completion of the engines, Winston 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, 2014, and requires annual rental payments of $437,297 each January 1, starting January 1, 2014 Winston's incremental borrowing rate is 11%. The implicit interest rate used by Ewing Inc. and known to winston is 9%. The total cost of building the three engines is $2,573,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs

Explanation / Answer

The PV of lease payments = 437297*6.99525 = 3059001.83 Say 3059000

b) 1-Jan-14 Leased engines 3059000      Lease liability 3059000 c) 1-Jan-14 Lease receivable 3059000 Cost of goods sold 2573000     Sales Revenue 3059000     Inventory 2573000 d) Lessee's books 1-Jan-14 Lease liability 437297     Cash 437297 Lessor's books 1-Jan-14 Cash 437297    Lease receivable 437297

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