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

(e) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2017. (Prepare a lease amortization schedule for 2 years.)

Short answer

The total amount of interest expense and interest payable is $206,882.

Step-by-step solution

Meaning of Leased asset amortization

The amortization of a leased asset is determined by the asset's historical cost, expected economic life, residual value, and the amortization method. Most finance leases are amortized with continuous payments over the term of the lease and are customized to meet the specific needs of the lessee.

Preparing Journal Entries for Lessee

Date	Particular	Debit ($)	Credit ($)
Dec. 31, 2017	Interest Expense	206,882
	Interest Payable		206,882

Preparing Journal Entries for Lessor

Date	Particular	Debit ($)	Credit ($)
Dec. 31, 2017	Interest Receivable	206,882
	Interest Revenue		206,882

Preparing lease amortization

WINSTON INDUSTRIES Lease Amortization Schedule
Date	Annual lease Receipt/payments	Interest on Receivable/liability at 85	Reduction in receivable/ liability	Lease Receivable/ Liability
1/1/17				$3,000,000
1/1/17	$413,971	$ 0	$413,971	2,586,029
1/1/18	413,917	206,882	207,089	2,378,940
1/1/19	413,917	190,656	223,656	2,155,284