P21-12 (L02,4) (Lessee-Lessor Entries, Balance Sheet Presentation, Finance and S
ID: 2574023 • Letter: P
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 WinstonExplanation / Answer
1.
The lease should be treated as a capital lease by Winston Industries requiring the lessee to capitalize the leased asset. The lease qualifies for capital lease accounting by the lessee because:
(1) title to the engines transfers to the lessee, (2) the lease term is equal to the estimated life of the asset, and (3) the present value of the minimum lease payments exceeds 90% of the fair value of the leased engines. The transaction represents a purchase financed by instalment payments over a 10-year period.
For Ewing Inc. the transaction is a sales-type lease because a manufacturer’s profit accrues to Ewing. This lease arrangement also represents the manufacturer’s financing the transaction over a period of 10 years.
2.
7.80 x 384352 = 300000
Dealer Profit
Sales (present value of lease payments)..................................................... $3,000,000
Less cost of engines................................................................................... 2,600,000
Profit on sale.............................................................................................. $ 400,000
(b) Leased Engines Under Capital Leases...................................... 3,000,000
Lease Liability.................................................................. 3,000,000
(c) Lease Receivable....................................................................... 3,000,000
Cost of Goods Sold................................................................... 2,600,000
Sales.................................................................................. 3,000,000
Inventory.......................................................................... 2,600,000
(d) Lessee (January 1, 2017)
Lease Liability........................................................................... 384,352
Cash.................................................................................. 384,352
Lessor (January 1, 2017)
Cash …………………………………………………………... 384,352
Lease Receivable.............................................................. 384,352
Lessee (December 31, 2017)
Interest Expense........................................................................ 156,939
Interest Payable................................................................ 156,939
Lessor (December 31, 2017)
Interest Receivable.................................................................... 156,939
Interest Revenue 156,939
(f) WINSTON INDUSTRIES
Balance Sheet
December 31, 2017
Property, plant, and equipment:
Current liabilities:
Leased property under capital leases
$3,000,000
Interest payable
$ 156,939
Less accumulated depreciation
300,000*
Lease liability
227,413
Long-term liabilities:
$2,700,000
Lease liability (See schedule)
2,388,235
*$3,000,000 ÷ 10 = $300,000
EWING INC.
Balance Sheet
December 31, 2017
Assets
Current assets:
Interest receivable................................................................................... $ 156,939
Lease receivable...................................................................................... 227,413
Noncurrent assets:
Lease receivable...................................................................................... $2,388,235*
*See balance on amortization schedule at 1/1/18.
WINSTON INDUSTRIESLease Amortization Schedule
Date Annual Lease Receipt/ Payment Interest on Receivable/ Liability at 6% Reduction in Receivable/ Liability Lease Receivable/ Liability 01/01/2017 3,000,000 01/01/2017 384,352 384,352 2,615,648 01/01/2018 384,352 156,939 227,413 2,388,235 01/01/2019 384,352 143,294 241,058 2,147,177
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