Question

Bidwell Leasing purchased a single-engine plane for $520,000 and leased it to Red Baron Flying Club for its fair value of $971,074 on January 1, 2021. (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 $170,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 through 2027. Red Baron knows that 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)	$	971,074
Lease payments at the beginning of each of the next eight years: ($971,074 ÷ 5.7122*)	$	170,000

* 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 consummating the completed lease transaction incurred by Bidwell Leasing were $26,557.

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, 2021.
3. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club.
4. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2021 (the second lease payment). Both companies use straight-line depreciation.
5. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2027 (the final lease payment).

Answer 1