Johnson Co enters into a lease agreement as a lessor on January 1, 2014, to leas

Question

Johnson Co enters into a lease agreement as a lessor on January 1, 2014, to lease an airplane to ABC Airlines. The term of the non-cancelable lease is eight years and payments are required to be made at the beginning of the period, starting with lease inception. The following information relates to this agreement:

1. ABC Airlines has the option to purchase an airplane for 12,000,000 when the lease expires at which time the fair value is expected to be $20,000,000. It is agreed by both parties that the terms reflecy a bargain purchase agreement.

2. The airplane has a cost of $51,000,000 to Johnson, an estimated useful life of fourteen years, and a salvage value of 0 at the end of that time (due to technological obsolescense)

3. National airlines will pay all executory costs related to the leased airplane

4. Annual beginning of year lease payments of 7,172,753 are computed to enable Johnson to earn an 8% return on its investment

5. Collectability of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by Lucas.

a. What type of lease is this? Discuss.

b. Verify the computation of the annual lease payments

c. Prepare a lease amortization schedule for the lessor for the first two years (2014-2015) (Round to nearest dollar.)

d. Prepare journal entries on the books of the lessor to record the lease agreement, to reflect payments received under the lease, and to recognize revenue, for 2014. Show all work and calculations

Explanation / Answer

a.

This type of lease is a direct financing lease as the bargain purchase option is satisfied in this lease.

Under a direct financing lease this type of option is required.

Also as the lessee can purchase the airplane so this is a capital lease from lessor point of view.

b.

Computation of the annual lease payments is calculated as shown below:

($51,000,000 - (12,000,000* .54027))*6.20637 = $7,172,753

c.

Lease amortization schedule is prepared as under:

d.

Journal entries on the books of the lessor to record the lease agreement, to reflect payments received under the lease, and to recognize revenue, for 2014 is shown as under:

A B C D Year Lease Payment Interest (8%) Reduction of Lease Obligation Balance of Lease Obligation (D*8%) (A-B) (D-C) Beginning 01-01-2014 510,00,000 01-Jan-14 71,72,753 71,72,753 438,27,247 01-Jan-15 71,72,753 35,06,180 36,66,573 401,60,674

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