Reference no: EM131792236

Question - 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 specification. Upon completion of the engines, Winston has agreed to lease them for period of 10 years and assume all cost and risk ownership. The lease is noncancelable, becomes effective on January, 2011, and requires rental payments of $413,971 each January 1, starting January 1, 2011.

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. Collectivity of the lease payment is reasonable certain; no uncertainties exist relative to unreimbursable lessor cost.

Instructions - Round all numbers to the nearest dollar.

A) Discuss the nature of this lease transaction for viewpoints of both lessee and lessor.

B) Prepare the journal entry or entries to record the transaction on January 1, 2011, on the books of Winston Industries.

C) Prepare the Journal entry or entries to record the transaction on January 1, 2011, 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, 2011.

E) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2011. (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, 2011, for both lessee and lessor.