(Lessee-Lessor Entries, Balance Sheet Presentation, 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 noncancelable, becomes effective on January 1, 2014, and requires annual rental payments of $413,971 each January 1, starting January 1, 2014.
Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. 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 reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.
|(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, 2014, on the books of Winston Industries.|
|(c)||Prepare the journal entry or entries to record the transaction on January 1, 2014, on the books of Ewing Inc.|
|(d)||Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2014.|
|(e)||Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2014. (Prepare a lease amortization schedule for 2 years.)|
|(f)||Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2014, for both the lessee and the lessor.|