Question

Bidwell Leasing purchased a single-engine plane for its fair value of $599,781 and leased it to Red Baron Flying Club 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:

1. Eight annual payments of $105,000 beginning January 1, 2018, the beginning 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:

Amount to be recovered (fair value)	$	599,781
Lease payments at the beginning of each of the next eight years: ($599,781÷ 5.7122*)	$	105,000

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

2. Red Baron's incremental borrowing rate is 12%.
3. Incremental Costs of negotiating and consummating the completed lease transaction incurred by Bidwell Leasing were $16,403.

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. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)
3. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club. (Round your intermediate calculations to the nearest dollar amount.)
4. Determine the effective rate of interest for Bidwell Leasing for the purpose of recognizing interest revenue over the lease term.
5. Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Bidwell Leasing. (Round your intermediate calculations to the nearest dollar amount.)
6. 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. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Round your intermediate calculations to the nearest dollar amount.)
7. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2024 (the final lease payment). Both companies use straight-line depreciation. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Round your intermediate calculations to the nearest dollar amount.)

Answer 1

ANSWER:

Requirement 1:

Classifying the Lease:

The following are four criteria for determining whether a lease is a capital lease or an operating lease:

• The property being transferred to the lessee at the end of the lease period.
• The purchase agreement of lease is less than market value.
• The lease term is equal to 75%  or more of the expected economic life of the asset.
• The present value of lease payments is equal to or more than 90% of the property’s market value.

If a lease meets any one of the above four criteria, it would be considered as capital lease. If a lease does not meet any of the above four criteria, it would be considered as operating lease.

Since,

The present value of the minimum lease payments of $599,781 is more than 90% of the Fair value i.e., 599,781 * 90% = 539,803

The economic life of the lease is 8 years which is 75% or more than the property useful life.

As, the two criteria's are met, It is a Capital Lease for both Lessor and Lessee.

Requirement 2:

Journal Entries in the Books of

Red Baron Flying Club

as on January 1, 2018

Date	Particulars	Debit (in $)	Credit (in $)
Jan 1, 2018	Leased Equipment	599,781
	To Lease Payable		599,781
	(To record the lease payable)
Jan 1, 2018	Lease Payable	105,000
	To Cash		105,000
	(To record the payment annual lease payment)

Journal Entries in the Books of

Bidwell

as on January 1, 2018

Date	Particulars	Debit (in $)	Credit (in $)
Jan 1, 2018	Lease Receivable	599,781
	To Inventory of equipment (lessor’s cost)		599,781
Jan 1,2018	Lease receivable	16,403
	To Cash		16,403
Jan 1, 2018	Cash	105,000
	To  Lease receivable		105,000

Requirement 3:

Amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club:

Date	Payment (A)	Effective Interest (previous year outstanding bal. x 11%) (B)	Decrease in balance (C = A - B)	Outstanding Balance (D) (D = D - C
				599,781
1/1/18	105,000		105,000	494,781‬
12/31/18	105,000	54,426	50,574	444,207‬
12/31/19	105,000	48,863	56,137	388,070
12/31/20	105,000	42,688	62,312	325,758‬
12/31/21	105,000	35,833	69,167‬	256,591‬
12/31/22	105,000	28,225	76,775	179,816‬
12/31/23	105,000	19,780	85,220	94,596‬
12/31/24	105,000	10,404	94,596	0
Total	840,000	240,219‬	599,781‬

Requirement 4:

Determine the effective rate of interest for Bidwell Leasing for the purpose of recognizing interest revenue over the lease term:

With the initial direct costs, the lease payments are the same, but the net investment is higher for Bidwell

= 599,781 + 16,403 = $616,184

The effective rate of interest = Lessor investment / Lease Payment = 616,184 / 105,000 = 5.8684

Requirement 5:

Amortization schedule that describes the pattern of interest revenue over the lease term for Bidwell Leasing:

The net investment is amortized at the 10%

Date	Payment (A)	Effective Interest (previous year outstanding bal. x 10%) (B)	Decrease in balance (C = A - B)	Outstanding Balance (D) (D = D - C
				616,184
1/1/18	105,000		105,000	511,184‬
12/31/18	105,000	51,118	53,882	457,302
12/31/19	105,000	45,730	59,270	398,032
12/31/20	105,000	39,803	65,197	332,835
12/31/21	105,000	33,284	71,716	261,119
12/31/22	105,000	26,112	78,888	182,231
12/31/23	105,000	18,223	86,777	95,454
12/31/24	105,000	9,546	95,454	0
Total	840,000	223,816	616,184

Requirement 6:

Journal Entries in the Books of

Red Baron Flying Club

as on December 31, 2018

Date	Particulars	Debit (in $)	Credit (in $)
12/31/2018	Interest Expense [11% * (599,781 - 105,000)]	54,425
	Lease payable (difference)	50,575
	To  Cash (lease payment)		105,000
12/31/2018	Depreciation Expense (599,781 / 8)	74,972
	To Accumulated depreciation		74,972

Journal Entries in the Books of

Bidwell

as on December 31, 2018

Date	Particulars	Debit (in $)	Credit (in $)
12/31/2018	Cash (lease payment)	105,000
	To Lease receivable (difference)		53,882
	To Interest revenue [10% * (616,184 - 105,000)		51,118

Requirement 7:

Journal Entries in the Books of

Red Baron Flying Club

as on December 31, 2024

Date	Particulars	Debit (in $)	Credit (in $)
12/31/2018	Interest Expense	10,404
	Lease payable (difference)	94,596
	To  Cash (lease payment)		105,000
12/31/2018	Depreciation Expense (599,781 / 8)	74,972
	To Accumulated depreciation		74,972

Journal Entries in the Books of

Bidwell

as on December 31, 2018

Date	Particulars	Debit (in $)	Credit (in $)
12/31/2018	Cash (lease payment)	105,000
	To Lease receivable (difference)		95,454
	To Interest revenue [10% * (616,184 - 105,000)		9,546