(The effects of buying versus leasing on the financial statements, LO 5)

Winterton Rail Ltd. (Winterton) is considering obtaining some new locomotives.

The purchase price of the locomotives is $59,724,975. Winterton is considering whether it should purchase the locomotives or lease them directly from the manufacturer. If Winterton buys the locomotives, it would borrow the full purchase price from a large institutional lender and repay the loan by making an annual blended payment of $7,500,000 on the last day of each of the next 20 years. If Winterton leases the locomotives, it would make annual lease payments of $7,500,000 to the manufacturer on the last day of each of the next 20 years.

Required:

a. Prepare the journal entries that Winterton would make if it borrowed the money and purchased the locomotives.

b. Prepare the journal entries that Winterton would make when the lease agreement is signed if it leased the locomotives and the lease were considered a capital lease.

c. Prepare the journal entries that Winterton would make when the lease agreement is signed if it leased the locomotives and the lease were considered an operating lease.

d. Compare the three alternatives in (a), (b), and (c). Explain the similarities and differences among them. Under what circumstances might one of the alternatives be preferred over the others? Explain.