Question

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, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

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.

Instructions

(b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Winston Industries.

Short answer

Lease Liability is $3,000,000.

Step-by-step solution

Meaning of Lease Liability

Lease liability means the amount of the lease liability in respect of any lease that would be required to be included in the statement of financial position prepared in accordance with the IFRS at the time of any determination and shall have a maturity period before the first date of such lease.

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
	Leased Equipment	3,000,000
	Lease Liability		3,000,000

Working Notes:

Calculation of Leased Equipment value

$\begin{array}{rcl}\mathrm{Lease}\mathrm{equipment}& =& \mathrm{Annual}\mathrm{rental}\times \mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{annuity}\\ & =& \$413,917\times 7.24689\\ & =& \$3,000,000\end{array}$

Note: Present value of an annuity due at 8% for 10 years, rounded by $2.