Bidwell Leasing purchased a single-engine plane for $540,000 and leased it to Re

Question

Bidwell Leasing purchased a single-engine plane for $540,000 and leased it to Red Baron Flying Club for its fair value of $742,586 on January 1, 2018. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Terms of the lease agreement and related facts were:

Eight annual payments of $130,000 beginning January 1, 2018, the inception of the lease, and at each December 31 through 2024. Bidwell Leasing’s implicit interest rate was 11%. The estimated useful life of the plane is eight years. Payments were calculated as follows:

* Present value of an annuity due of $1: n = 8, i = 11%

Red Baron’s incremental borrowing rate is 12%.

Costs of negotiating and consummating the completed lease transaction incurred by Bidwell Leasing were $15,622.

Required:
1. How should this lease be classified (a) by Bidwell Leasing (the lessor) and (b) by Red Baron (the lessee)?
2. Prepare the appropriate entries for both Red Baron Flying Club and Bidwell Leasing on January 1, 2018.
3. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club.
4. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2018 (the second lease payment). Both companies use straight-line depreciation.
5. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2024 (the final lease payment).

Amount to be recovered (fair value) $ 742,586 Lease payments at the beginning of each of the next eight years: ($540,000 ÷ 5.7122*) $ 130,000

Explanation / Answer

Solution:

1) a) by Bidwell Leasing (the lessor):

This will be the Capital Lease to the Lessor. The Fair Value of the Property will exceeds the Lessor's Carrying Value, the Plane was sold to make Profit. Since, this will be a Sales Type Lease:

Fair value $742,586

(-) Carrying value ($540,000)

Dealer’s profit $202,586

(b) by Red Baron (the lessee):

This will be the Capital Lease for the Lessee. Red Baron will Record the Present Value of Lease Payments as a Leased Asset and Leased Liability.

2) Preparing the Appropriate entries for both Red Baron Flying Club and Bidwell Leasing on January 1, 2018:

3) Preparing the amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club:

Effective Interest

(11% * Outstanding Balance)

4) Preparing the Journal Entries for both Red Baron and Bidwell Leasing on December 31, 2018:

5) Preparing the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2024:

General Journal Debit Credit Red Baron Flying Club (Lessee) Leased equipment $742,586 Lease payable $742,586 Lease payable $130,000 Cash $130,000 Bidwell Leasing (Lessor) Lease receivable $742,586 Cost of goods sold (lessor’s cost) $540,000 Sales revenue $742,586 Inventory of equipment (lessor’s cost) $400,000 Selling expense $15,622 Cash (initial direct costs) $15,622 Cash (lease payment) $130,000 Lease receivable $130,000

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