P21-12 (L02,4) (Lessee-Lessor Entries, Balance Sheet Presentation, Finance and S

Question

P21-12 (L02,4) (Lessee-Lessor Entries, Balance Sheet Presentation, Finance and Sales-Type Lease) 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 non-cancelable, becomes effective on January 1, 2017, and requires annual rental payments of $384,532 each January 1, starting January 1, 2017 Winston's incremental borrowing rate is 8%. The implicit interest rate used by Ewing and known to Winston is 6%. The total cost of building the three engines is $2,600,000. 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 probable. Problems 21-70 Instructions (a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor. (b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Winston (the lessee), (c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Ewing (the lessor) (d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1,2017 (e) Prepare the journal entries for both the lessee and lessor to record any entries needed in connection with the lease at December 31, 2017. (Prepare a lease amortization schedule for 2 years.) lessee and the lessor receives a lease incentive from Ewing of $50,000 to enter the lease. How will this affect your answer to part (b)? (D Show the items and amounts that would be reported on the balance sheet (not notes) at December 31,2017, for both the (g) Assume that Winston incurs legal fees related to the execution of the lease of $30,000. In addition, assume Winston

Explanation / Answer

a) From the viewpoints of Lessor and lessee, the nature of lease transaction is Finance or Capital Lease Year Lease Payment PVIF@6% Present Value of lease Payment PVIF@8% Present Value of lease Payment Interest to be recoginised 0 384532 1 384532.00 1 384532 1 384532 0.943396 362766.04 0.925926 356048.1 2 384532 0.889996 342232.11 0.857339 329674.2 3 384532 0.839619 322860.48 0.793832 305253.9 4 384532 0.792094 304585.36 0.73503 282642.5 5 384532 0.747258 287344.68 0.680583 261706 6 384532 0.704961 271079.89 0.63017 242320.4 7 384532 0.665057 255735.74 0.58349 224370.7 8 384532 0.627412 241260.13 0.540269 207750.7 9 384532 0.591898 227603.90 0.500249 192361.7 3845320 3000000.33 2786660 Since, Present Value of Minimum lease payment is @6% is 3000000 is the fair value and Present value of Minimum Lease payment from Lessee's Point of view is 2786660 Lease will be recognised at lower of above two in the books of lessee. b) Journal entries to record the transaction in the books of Winston is as follow Explanation Debit Credit Leased Asset 2786660 Leased Liability 2786660 Being recognition of lease at the inception. c) Journal entries to record the transaction in the books of Ewing is as follow Explanation Debit Credit Lease Receivable 2786660 Leased Asset 2786660 Being recognition of lease at the inception. d) Journal entries to record the first rental payment in the books of Winston is as follow Explanation Debit Credit Leased rent 384532 Cash 384532 Being payment of leased rent Finance charge or Interest 384532 Lease liability 0 Leased rent 384532 Journal entries to record the first rental payment in the books of Ewing is as follow Explanation Debit Credit Cash 384532 Leased rent 384532 Being receipt of Leased rent Leased rent 384532 Interest or finance charges 0 Lease receivable 384532

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