On January 1, 2020, Hawkeye Air leased a new airplane for 5 years. The expected life...

On January 1, 2020, Hawkeye Air leased a new airplane for 5 years. The expected life of the airplane is 20 years. The lease stipulates that Hawkeye Air makes annual payments of $1,085,923 payable at the beginning of each year. Hawkeye Air has an incremental borrowing rate of 4.3%. Hawkeye Air has an option to renew the lease with a 2% increase in the lease payment.

1) How will the lease be classified and how do you know?

1b) Calculate the present value of the lease payments.

2) What is the balance sheet impact of the lease at the beginning of the lease (1/1/2020)?

2a) What is the income statement impact of the lease for 2020?

2b) Identify any effects the lease arrangement and the associated reporting would have on the statement of cash flows for 2020.

Expert Solution

Answer:

1. The lease is an operating lease. It did not meet thr major criteria intended for a finance lease. There was no transfer of ownership at the end, nor a bargain purchase option, and 5 yrs is not a major part of the 20 yr life of the airplane.

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2. 4,793,862 : PVF 4.4145... * 1,085,923 lease payments. The PVF or the Present Value Factor is calculated through a formula of [1- (1+i)^n] divided by i so it means [1- (1+ 0.043)^5]/ 0.043

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3. There's no impact on the balance sheet in year 2020 onwards, note that it is classified as an operating lease meaning no recognition of the asset to the lessee because the ownership of the airplane still is in the hands of the lessor.

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4. Nothing yet, note that the payment is to be made annually of the beginning of each year, so the first payment to be made will partake at 1/1/2021. It was not stated whether the first payment was made on 1/1/2020 and the same cannot be assumed.

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5. As for the year 2020, there are no effects yet. The only time you are to record anything on your journal entry in this type of lease is when the payment has been made by the lessee decreasing the lessee's cash and increasing his rental expense of the year.

ekkarill92 answered 3 months ago

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