Question

In: Accounting

On January 1, 2011, Southwest and the Boeing Company (NYSE:BA), the aircraft manufacturer, entered into a...

On January 1, 2011, Southwest and the Boeing Company (NYSE:BA), the aircraft manufacturer, entered into a lease agreement to lease 3 new Boeing 737-800 passenger airplanes. The lease term is 20 years, which is equal to the useful life of the airplanes. At the end of the lease term the equipment will have zero residual value and will be returned to Boeing. The lease specifies annual payments of $25 million beginning January 1, 2011, and then on January 1 of each year through 2030. Southwest's incremental borrowing cost is 12%. The implied interest rate used by Boeing in structuring the lease is 10%, which is known to Southwest. Boeing's cost to manufacture the airplanes is $190 million. Both Boeing and Southwest use the straight-line depreciation method. There is no uncertainty with collectability of the lease payments or any additional cost to Boeing after the delivery of the airplane upon the inception of the lease. Answer the following questions and show your work.

A. How should this lease be classified by Boeing and Southwest?

B. Show all the journal entries Southwest needs to prepare in 2011 and on January 1, 2012.

C. Show all the journal entries Boeing needs to prepare in 2011 and on January 1, 2012.

Solutions

Expert Solution

A. Boeing,being the lessor, should classify the lease as direct financing lease
Sothwest,being the lessee, should classify the lease as capital lease since the lease period (20 years) is more than 75% of useful life of the equipment (20 years)
B. Present value of minimul lease payment:
$
Annual lease payment 25000000
Present value at implicit rate of 10% for 20 years
(Implicit rate of interest is considered here
since it is less than incremental borrowing
rate of 12%) 9.3649 *
Present value of minimul lease payment 234122500
*
lease is payable at the beginning of the period
Hence, while computing present value,PV factor for the first period will be 1.
For the next priod will be PV factor for first year
For the next priod will be PV factor for second year and so on
Journal entry:
Date Account titles and explanation Debit Credit
2011
Jan 1. Leased equipment 234122500
Lease payable 234122500
(Lease recorded)
Lease payable 25000000
Cash 25000000
(Lease rental paid)
Dec 31. Depreciation expense (234122500/20) 11706125
Accumulated depreciation 11706125
(Depreciation recorded)
Interest expense (234122500-25000000)*10% 20912250
Interest payable 20912250
(Interest accrued on lease)
2012
Jan 1. Lease payable (25000000-20912250) 4087750
Interest payable 20912250
Cash 25000000
(Lease rental paid)
c. In the books of Boeing:
Date Account titles and explanation Debit Credit
2011
Jan 1. Lease receivable 190000000
Inventory 190000000
(Lease recorded)
Cash 25000000
Lease receivable 25000000
(Lease rental received)
Dec 31. Interest receivable (190000000-25000000)*10% 16500000
Interest revenue 16500000
(Interest accrued on lease)
2012
Jan 1. Cash 25000000
Lease receivable (25000000-16500000) 8500000
Interest receivable 16500000
(Lease rental received)

ekkarill92 answered 2 years ago
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