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

(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.

Short answer

The lease liability is $413,971.

Step-by-step solution

Meaning of Lease

A mutually agreed contract by two different partiesto do an activity in which one person will provide his asset to another person bycharging some specific amount is known as Lease.

Preparing Journal Entries for Lessee

Date	Particular	Debit ($)	Credit ($)
Jan. 1, 2017	Lease Liability	413,971
	Cash		413,971

Preparing Journal Entries for Lessor

Date	Particular	Debit ($)	Credit ($)
Jan. 1, 2017	Cash	413,971
	Lease Receivable		413,971