Answer to Leasing Part I

Question 2
(a) The lease should be treated as a capital (financial) lease by Winston Industries requiring the
lessee to capitalize the leased asset. The lease qualifies for capital lease accounting by the lessee
because: (1) title to the engines transfers to the lessee, (2) the lease term is equal to the estimated
life of the asset, and (3) the present value of the minimum lease payments exceeds 90% of the
fair value of the leased engines. The transaction represents a purchase financed by installment
payments over a 10-year period.

For Ewing Inc. the transaction is a sales-type lease because a manu-facturer’s profit accrues to Ewing. This
lease arrangement also represents the manufacturer’s financing the transaction over a period of 10 years.

Present Value of Lease Payments

$413,971 X 7.24689 ................................................................................ $ 3,000,000

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

Dealer Profit
Sales (present value of lease payments) ......................................................... $ 3,000,000
Less cost of engines ....................................................................................... 2,600,000
Profit on sale .................................................................................................. $ 400,000

(b) Leased Engines Under Capital Leases .......................................... 3,000,000

Lease Liability ................................................................................... 3,000,000

(c) Lease Receivable .......................................................................... 3,000,000

Cost of Goods Sold ....................................................................... 2,600,000
Sales ................................................................................................... 3,000,000
Inventory ............................................................................................ 2,600,000

(d) Lessee (January 1, 2012)

Lease Liability .............................................................................. 413,971
Cash ................................................................................................... 413,971

Lessor (January 1, 2012)

Cash ............. .............................................................................. 413,971
Lease Receivable ............................................................................... 413,971
(e)
WINSTON INDUSTRIES
Lease Amortization Schedule

Annual Lease
Receipt/ Payment Interest on Reduction in Receivable/ Lease Receivable/
Receivable/ Liability Liability
Date Liability at 8%
1/1/12 3,000,000
1/1/12 413,971 413,971 2,586,029
1/1/13 413,971 206,882 207,089 2,378,940
1/1/14 413,971 190,315 223,656 2,155,284

Lessee (December 31, 2012)

Interest Expense ............................................................................ 206,882
Interest Payable .................................................................................. 206,882

Lessor (December 31, 2012)

Interest Receivable........................................................................ 206,882
Interest Revenue ................................................................................. 206,882

(f)
WINSTON INDUSTRIES
Balance Sheet
December 31, 2011

Property, plant, and equipment: Current liabilities:

Leased property under

capital leases $3,000,000 Interest payable $ 206,882
Lease liability 207,089**
Less accumulated
depreciation 300,000* Long-term liabilities:
$2,700,000 Lease liability (See 2,378,940***
schedule)

*$3,000,000 ÷ 10 = $300,000
**($413,971 – $206,882)
***No portion of this amount paid within the next year.

Note: The title Obligations under Capital Leases is often used instead of lease liability.
 EWING INC.
Balance Sheet
December 31, 2011

Assets
Current assets:
Interest receivable ...................................................................................... $ 206,882
Lease receivable .............................................................................................. 207,089

Noncurrent assets:
Lease receivable ....................................................................................... $2,378,940*

Note: The title Net Investment in Sales-Type Leases is often shown instead of lease receivable.

*See balance on amortization schedule at 1/1/12.