Question 1 (20 marks)

PCL Limited and ABN Limited enter into an agreement that requires ABN to build 10 diesel-electric packages to PCL's specifications. Upon completion of the packages, PCL has agreed to lease them starting on 1 January 2020 for a period of 10 years and to assume all costs and risks of ownership. The lease is non-cancelable and requires equal annual rental payments at the beginning of each calendar year starting 1 January 2020.

The implicit interest rate used by ABN is 6%, which is known to PCL. The total cost of building the packages is $2,700,000, and fair value is $4,000,000 on 1 January 2020. The economic life of the packages is estimated to be 10 years. The lease has a guaranteed residual value of $500,000. It is expected by PCL that the packages will have a residual value of $380,000. At the end of the lease, the packages will be passed back to ABN. Collectability of the lease payments is probable. Both companies depreciate similar packages on a straight-line basis.

Required: (Round all amounts to the nearest dollar.)

(a) How much is the annual rental ABN would ask for? (2 marks)

(b) Calculate the initial balance of Lease Liability for PCL. (2 marks)

(c) Prepare all journal entries for the year ended 31 December 2020 in the books of ABN. (8 marks)

(d) Prepare all journal entries for the year ended 31 December 2020 in the books of PCL. (8 marks)

PV of $1 PV of an Ordinary Annuity of $1 PV of an Annuity Due of $1

i = 6%, n = 10 0.5584 7.3601 7.8017