Prairie Railroad Inc. (PRI) (the lessee) and Loco-Motive Corporation (LMC) (the lessor) enter into an agreement that requires LMC to build a diesel-electric engine to PRI’s specifications. Upon completion of the engine, PRI has agreed to lease it for a period of 12 years and to assume all costs and risks of ownership. The lease is non-cancellable, becomes effective on January 1, 2019, and requires annual rental payments of $280,000 first due on the commencement date of the lease. 

PRI’s incremental borrowing rate is 13%, and the implicit interest rate used by LMC, which is not readily determinable by PRI, is 12%. The total cost of building the engine is $1,550,000. The economic life of the engine is estimated to be 12 years with residual value set at zero. PRI depreciates similar equipment on a straight-line basis. At the end of the lease, PRI obtains title to the engine. 

Required: 

a. Evaluate how the lessor (LMC) should account for the lease transaction. 

b. Prepare a lease amortization schedule for this lease for LMC, the lessor. 

c. Prepare a lease amortization schedule for this lease for PRI, the lessee. 

d. Prepare the journal entries on January 1, 2019, and December 31, 2019, for LMC, the lessor. 

e. Prepare the journal entries on January 1, 2019, and December 31, 2019, for PRI, the lessee. 

f. Show the items and amounts that would be reported for both parties as at December 31, 2019. Clearly distinguish current from non-current items.