Question

Bidwell Leasing purchased a single-engine plane for $500,000 and leased it to Red Baron Flying Club for its fair value of $913,952 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 $160,000 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)	$	913,952
Lease payments at the beginning of each of the next eight years: ($500,000 ÷ 5.7122*)	$	160,000

* 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 $24,995.

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

1. Bidwell leasing will classify such a leasing agreement as finance lease in it's books of accounts. This is due to the reason that the plane will be leased for 8 years which is the total useful life of the asset. Therefore, asset will not be used by the purchasing company during the useful life of asset. Moreover, the plane is given on lease rentals which is equal to the fair market value of the asset.

Red Baron will also account for finance lease in the books of account.

2. a. Journal Entry in books of lessor

Date	Particulars	Amount	Amount
01-Jan-2018	Lease Receivable TO Asset (Being lease receivable recorded at fair value net of costs)	913,952	913,952

Journal entry in books of Lessee for finance lease

Date	Particulars	Amount	Amount
01-Jan-2018	Lease Asset To Lease Liability (Being asset recorded & liability created at fair value)	913,952	91,3952