Lee Industries Inc. and Lor Inc. enter into an agreement that requires Lor to build three diesel-electric engines to Lees specifications. Both Lee and Lor follow ASPE and have calendar year ends. On completion of the engines, Lee has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is non-cancellable, becomes effective on January 1, 2023, and requires annual rental payments of $620,956 each January 1, starting January 1, 2023. Lees incremental borrowing rate is 10%, and the implicit interest rate used by Lor is 8% and is known to Lee. The total cost of manufacturing the three engines is $3.9 million. The engines economic life is estimated to be 10 years, with residual value expected to be zero. Lee depreciates similar equipment on a straight-line basis. At the end of the lease, Lee assumes title to the engines. Collectibility of the lease payments is reasonably certain and there are no uncertainties about unreimbursable lessor costs.

Instructions

1. Answer the following questions, rounding all numbers to the nearest dollar. Discuss the nature of this lease transaction from the viewpoints of both the lessee (Lee) and lessor (Lor). Show calculations using any of the following methods: (1) factor tables, (2) a financial calculator, or (3) Excel function.
2. Prepare the journal entry or entries to record the transactions on January 1, 2023, on the books of Lee.
3. Prepare the journal entry or entries to record the transactions on January 1, 2023, on the books of Lor.
4. Prepare the journal entries for both the lessee and lessor to record interest expense (income) at December 31, 2023. (Prepare a lease amortization schedule for the lease obligation for two years using Excel.)
5. Show the items and amounts that would be reported on the SFP (ignore the notes) at December 31, 2023, for both the lessee and the lessor.
6. Identify how the lease transactions would be reported on each companys statement of cash flows in 2023.
7. Provide the note disclosure concerning the lease that would be required for the lessee, Lee, on its financial statements for the fiscal year ended December 31, 2023.
8. Provide the note disclosure concerning the lease that would be required for the lessor, Lor, on its financial statements for the fiscal year ended December 31, 2023.