1. Loss Contingencies: Entries and Essay
On November 24, 2014, 26 passengers on Windsor Airlines Flight No. 901 were injured upon landing when the plane skidded off the runway. Personal injury suits for damages totaling $9,000,000 were filed on January 11, 2015, against the airline by 18 injured passengers. The airline carries no insurance. Legal counsel has studied each suit and advised Windsor that it can reasonably expect to pay 60% of the damages claimed. The financial statements for the year ended December 31, 2014, were issued February 27, 2015.
Instructions
(a) Prepare any disclosures and journal entries required by the airline in preparation of the December 31, 2014, financial statements.
(b) Ignoring the November 24, 2014, accident, what liability due to the risk of loss from lack of insurance coverage should Windsor Airlines record or disclose? During the past decade, the company has experienced at least one accident per year and incurred average damages of $3,200,000. Discuss fully.
Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2014.
2. Lessee-Lessor Entries, Balance Sheet Presentation, Sales-Type Lease
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, 2014, and requires annual rental payments of $413,971 each January 1, starting January 1, 2014.
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
(a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.
(b) Prepare the journal entry or entries to record the transaction on January 1, 2014, on the books of Winston Industries.
(c) Prepare the journal entry or entries to record the transaction on January 1, 2014, on the books of Ewing Inc.
(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2014.
(e) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2014. (Prepare a lease amortization schedule for 2 years.)
(f) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2014, for both the lessee and the lessor.