Refer to the information in P13–10. Assume that at the commencement of the lease, collectibility of the payments is not probable and the lessor uses the straight-line depreciation method.

Required:

1. Prepare the necessary journal entries for Railcar for 20X1 and 20X2 under the lease. You do not have to make journal entries to reclassify any of the receivable to current assets.

2. How much income does Railcar show on its income statement in 20X1 and 20X2 because of the lease? How does your answer compare to the income recognized in 20X1 and 20X2 in P13–10?

3. Assume that because of Reading Railroad’s improved financial health, on January 1, 20X4, Railcar views the collection of lease payments to be probable. What journal entry would Reading make on January 1, 20X4, related to the lease? Assume that the January 1, 20X4, payment has been made.

P13–10.

On January 1, 20X1, Railcar Leasing Inc. (the lessor) purchased 10 used boxcars from Railroad Equipment Consolidators at a price of $8,749,520. Railcar leased the boxcars to the Reading Railroad Company (the lessee) on the same date. The lease is for eight years and calls for eight annual payments of $1,500,000 to be made at the beginning of each year, with the first payment due on January 1, 20X1. The boxcars have a nine-year remaining useful life, the lease contains no renewal or bargain purchase option, and possession of the boxcars reverts to the lessor at the lease’s end. The lessor expects the boxcars to be worth $1,000,000 at the end of the lease term, but this value is not guaranteed by the lessee. The payments’ collectibility is reasonably certain, with no important uncertainties regarding unreimbursable costs to be incurred by the lessor. The lessor has structured the lease to earn a rate of return of 12.0%.