Question

Bidwell Leasing purchased a single-engine plane for $540,000 and leased it to Red Baron Flying Club for its fair value of $742,586 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:

Eight annual payments of $130,000 beginning January 1, 2018, the inception 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)	$	742,586
Lease payments at the beginning of each of the next eight years: ($540,000 ÷ 5.7122*)	$	130,000

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

Red Baron’s incremental borrowing rate is 12%.

Costs of negotiating and consummating the completed lease transaction incurred by Bidwell Leasing were $15,622.

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.
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, 2018 (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, 2024 (the final lease payment).

Answer 1

Solution:

1) a) by Bidwell Leasing (the lessor):

This will be the Capital Lease to the Lessor. The Fair Value of the Property will exceeds the Lessor's Carrying Value, the Plane was sold to make Profit. Since, this will be a Sales Type Lease:

Fair value $742,586

(-) Carrying value ($540,000)

Dealer’s profit $202,586

(b) by Red Baron (the lessee):

This will be the Capital Lease for the Lessee. Red Baron will Record the Present Value of Lease Payments as a Leased Asset and Leased Liability.

2) Preparing the Appropriate entries for both Red Baron Flying Club and Bidwell Leasing on January 1, 2018:

General Journal	Debit	Credit
Red Baron Flying Club (Lessee)
Leased equipment	$742,586
Lease payable		$742,586
Lease payable	$130,000
Cash		$130,000
Bidwell Leasing (Lessor)
Lease receivable	$742,586
Cost of goods sold (lessor’s cost)	$540,000
Sales revenue		$742,586
Inventory of equipment (lessor’s cost)		$400,000
Selling expense	$15,622
Cash (initial direct costs)		$15,622
Cash (lease payment)	$130,000
Lease receivable		$130,000

3) Preparing the amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club:

Lease Amortization Schedule
Date	Payments	Effective Interest (11% * Outstanding Balance)	Decrease in Balance	Outstanding Balance
				$742,586
1/1/2018	$130,000		$130,000	$612,586
12/31/2018	$130,000	$612,586 * 11% = $67,384	$62,616	$549,970
12/31/2019	$130,000	$549,970 * 11% = $60,497	$69,503	$480,467
12/31/2020	$130,000	$480,467 * 11% = $52,851	$77,149	$403,318
12/31/2021	$130,000	$403,318 * 11% = $44,365	$85,635	$317,683
12/31/2022	$130,000	$317,683 * 11% = $34,945	$95,055	$222,628
12/31/2023	$130,000	$222,628 * 11% = $24,489	$105,511	$117,117
12/31/2024	$130,000	$117,117 * 11% = $12,883	$117,117	$0
	1,040,000	$297,414	$742,586

4) Preparing the Journal Entries for both Red Baron and Bidwell Leasing on December 31, 2018:

General Journal	Debit	Credit
Red Baron Flying Club (Lessee)
Interest expense (11% x [$742,586 - $130,000])	$67,384
Lease payable (difference)	$62,616
Cash (lease payment)		$130,000
Depreciation expense ($742,586/8Yrs)	$92,823
Accumulated depreciation		$92,823
Bidwell Leasing (Lessor)
Cash (lease payment)	$130,000
Lease receivable (difference)		$62,616
Interest Revenue 11% * [$742,586 - $130,000]		$67,384

5) Preparing the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2024:

General Journal	Debit	Credit
Red Baron Flying Club (Lessee)
Interest expense (11%*$117,117)	$12,883
Lease payable (difference)	$117,117
Cash (lease payment)		$130,000
Depreciation expense ($742,586/8Yrs)	$92,823
Accumulated depreciation		$92,823
Bidwell Leasing (Lessor)
Cash (lease payment)	$130,000
Lease receivable (difference)		$117,117
Interest Revenue (11%*$117,117)		$12,883