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

(f) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2017, for both the lessee and the lessor.

Short answer

Capital lease is $300,000

Lease liability (current) is $207,089

Step-by-step solution

Meaning of Balance sheet

The balance sheet is the foremost basic of the three financial statementsused to provide thefinancial health of a company. The income statement and cash flow statement are the other two. A balance sheet helps stakeholders and investigators in evaluating a company's financial situation and capacity to meet its operational costs.

Preparing partial balance sheet to show items and amounts that would be reported

WINSTON INDUSTRIES Balance Sheet (Partial) December 31, 2017
Property, plant, and equipment: Leased property	$3,000,000	Current liabilities: Interest payable Lease liability	$ 206,882 207,089
Less accumulated depreciation capital leases	300,000	Long-term liabilities: Lease liability	2,378,940
	$2,700,000

Working Notes:

Calculation of Capital lease

$\begin{array}{rcl}\mathrm{Capital}\mathrm{lease}& =& \frac{\mathrm{Leased}\mathrm{property}}{\mathrm{Estimated}\mathrm{life}}\\ & =& \frac{\$3,000,000}{10}\\ & =& \$300,000\end{array}$

Calculation of Lease Liability (Current)

$\begin{array}{rcl}\mathrm{Lease}\mathrm{liability}& =& \mathrm{Annual}\mathrm{lease}\mathrm{payments}-\mathrm{Interest}\mathrm{payable}\\ & =& \$413,971-\$206,882\\ & =& \$207,089\end{array}$

Note: In lease liability, no portion of this amount will be paid within the next year. The title Obligations under Capital Leases is often used instead of the Lease liability.

Preparing partial balance sheet for Ewing Inc.

EWING INC. Balance Sheet (Partial) December 31, 2017
Assets
Current assets: Interest receivable Lease receivable	$ 206,882 207,089
Noncurrent assets: Lease receivable	$2,378,940

Note: The title Net Investment in leases is often shown instead of Lease receivable.

Lease receivable is the balance of the amortization schedule of 1/1/18.