1. On January 1, 2017, Flying High Airlines leased a new airplane for a term of
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Question
1. On January 1, 2017, Flying High Airlines leased a new airplane for a term of 10 years The expected life of the airplane is 20 years. There are no rights to purchase the asset at the end of the term, no bargain purchase option, and no residual value guarantee. The lease stipulates that Flying High makes annual payments of S650,000 beginning at the end of the first year (December 31, 2017). Flying High has an incremental borrowing rate of 4.5% and the fair market value ofthe airplane on January 1, 2017 is $6,250,000 (for simplicity, assume the lessors implicit rate is greater than 45%) a. What journal entries related to thelease arrangement should be recorded during 2017 (assume Flying High's fiscal year end is December 31) Identify any effects the lease arrangement and the associated reporting would have on the balance sheet, income statement, and statement of cash flows for 2017 b. C. What is the annual lease payment that results in a present value ofminimum lease payments equal to 90% of the fair market value of the airplane ($6,250,000)? 2. Now assume that the lessor decided to require the lease payments at the beginning of the bargain purchase option under which the lessee could purchase the airplane at the end of a. What jounal entries related to thelease arrangement should be recorded during year as opposed to the end of the year. Also assume that the lease arrangement had a the contract for $250,000 2017 Identify any effects the lease arrangement and the associated reporting would have on the balance sheet, income statement, and statement of cash flows for 2017 b.Explanation / Answer
1. PVA 4.5%, 10 years : 7.9127
a. Present value of the minimum lease payments = $ 650,000 x 7.9127 = $ 5,143,255
The present value is $ 5,143,255 / $ 6,250,000 * 100 = 82.29 % of the fair value of the asset at the inception of the lease. As the present value is less than 90% of the fair value of the asset, this should be classified as an operating lease, and recorded accordingly.
b. Lease rent expense of $ 650,000 will be reported on the 2017 income statement as an operating expense for computation of net operating income.
The cash outflow of $ 650,000 will be reported in the Operating Activities sction of the Statement of Cash Flows for the year ended December 31, 2017.
Because it is an operating lease, it would not be reported on the balance sheet, as title to the asset remains with the lessor.
c. Annual lease payments that would result in present value of minimum lease payments of 90 % of the fair market value of the airplane = $ (6,250,000 x 90% ) / 7.9127 = $ 710,883
2. PVAD4.5%, 10 years = 7.9127 x 1.045 = 8.26877
Present value of the minimum lease payments = $ 650,000 x 8.26877 = $ 5,374,700
The present value $ 5,374,700 / $ 6,250,000 = 86% is still less than 90% of the fair market value at the inception of the lease. But since there is a bargain purchase option at the end of the lease term, it qualifies as a capital lease, and should be recorded accordingly.
a.
b. The leased asset would be carried at its book value ( present value less accumulated depreciation) in the balance sheet asset side. The outstanding balance of lease liability would be carried on the liability side of the balance sheet.
Depreciation expense on the leased asset would be reported on the income statement as an operating expense, while the interest expense would be reported as finance cost.
On the statement of cash flows, depreciation expense would get added back in the Operating Activities Section, and the interest expense would be recorded on the Financing Activities Section.
Date General Journal Debit Credit $ $ December 31, 2017 Lease Rent Expense 650,000 Cash 650,000Related Questions
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