Question

Bidwell Leasing purchased a single-engine plane for $600,000 and leased it to Red Baron Flying Club for its fair value of $742,586 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: a. Eight annual payments of $130,000 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) $742,586 Lease payments at the beginning of each of the next to $130,000 eight years: ($742,586 = 5.7122*) * Present value of an annuity due of $1: n = 8, i = 11% b. Red Baron's incremental borrowing rate is 12%. c. Incremental costs of consummating the completed lease transaction incurred by Bidwell Leasing were $20,309.

Answer 1

Requirement 1
(a) By Bidwell Leasing (the lessor)	Capital lease	Since the fair value is the lessor’s cost, there is no dealer’s profit, making this a direct financing lease
(b) By Red Baron (the lessee)	Capital lease
Application of Classification Criteria
1)  Does the agreement specify that ownership of the asset transfers to the lessee?	No
2) Does the agreement contain a bargain purchase option?	No
3) Is the lease term equal to 75%  or more of the expected economic life of the asset?
{8 yrs.  > 75% of 8 yrs}	Yes
4) Is the present value of the minimum lease payments equal to or greater than 90% of the fair value of the asset?	Yes
{$742,586  > 90% of $742,586}
Requirement 2
Red Baron Flying Club (Lessee)
Date	Account titles & Explanation	Debit	Credit
Jan 1 ,2021	Leased equipment (calculated above)	742,586
	Lease payable (calculated above)		742,586
Jan 1 ,2021	Lease payable	130,000
	Cash		130,000
Bidwell Leasing (Lessor)
Jan 1 ,2021	Lease receivable	742,586
	Inventory of equipment (lessor’s cost)		742,586
Jan 1 ,2021	Lease receivable	20,309
	Cash (initial direct costs)		20,309
Jan 1 ,2021	Cash (lease payment)	130,000
	Lease receivable		130,000
Requirement 3
Lease Amortization Schedule
	A	B	C= A -B	Previous year Bal. - C
Date	Payments	Effective Interest  (previous year outstanding bal. x 11%)	Decrease in balance	Outstanding Balance
				$        742,586.00
1/1/21	$                                                                            130,000.00		$   130,000.00	$        612,586.00
12/31/21	$                                                                            130,000.00	$                      67,384.46	$     62,615.54	$        549,970.46
12/31/22	$                                                                            130,000.00	$                      60,496.75	$     69,503.25	$        480,467.21
12/31/23	$                                                                            130,000.00	$                      52,851.39	$     77,148.61	$        403,318.60
12/31/24	$                                                                            130,000.00	$                      44,365.05	$     85,634.95	$        317,683.65
12/31/25	$                                                                            130,000.00	$                      34,945.20	$     95,054.80	$        222,628.85
12/31/26	$                                                                            130,000.00	$                      24,489.17	$   105,510.83	$        117,118.03
12/31/27	$                                                                            130,000.00	$                      12,882.98	$   117,118.03	$                  (0.00)
Total	$                                                                         1,040,000.00	$                    297,415.01	$   742,586.00
Requirement 4
Date	Account titles & Explanation	Debit	Credit
Red Baron Flying Club (Lessee)
12/31/21	Interest expense (11% x [$742,586 – 130,000])	67,384
	Lease payable (difference)	62,616
	Cash (lease payment)		130,000
12/31/21	Depreciation expense ($742,586 ÷ 8 years)	92,823
	Accumulated depreciation		92,823
Bidwell Leasing (Lessor)
12/31/21	Cash (lease payment)	130,000
	Lease receivable (difference)		66,711
	Interest revenue (10% x [$762,895 – 130,000])		63,290
With the initial direct costs, the lease payments are the same, but the net investment is higher: $742,586 + 20,309 =	762,895
The new effective rate is the discount rate that equates the net investment and the future lease payments:
Lessor investment/Lease Payment
762,895  ÷ ?** = $130,000	5.868423077
present value of an annuity due of $1: n=8, i=	The net investment is amortized at the 10% rate.
Requirement 5
Red Baron Flying Club (Lessee)
12/31/27	Interest expense	12,883.0
	Lease payable (difference)	117,118.0
	Cash (lease payment)		130,000.0
12/31/27	Depreciation expense ($742,586 ÷ 8 years)	92,823
	Accumulated depreciation		92,823
Bidwell Leasing (Lessor)
12/31/27	Cash (lease payment)	130000
	Lease receivable (difference)		$   118,182.80
	Interest revenue (calculated below)		$     11,818.28
amortization schedule that describes the pattern of interest revenue over the lease term for Bidwell Leasing
Lease Amortization Schedule
	A	B	C= A -B	Previous year Bal. - C
Date	Payments	Effective Interest  (previous year outstanding bal. x 11%)	Decrease in balance	Outstanding Balance
				$        762,895.00
1/1/21	$                                                                            130,000.00		$   130,000.00	$        632,895.00
12/31/21	$                                                                            130,000.00	$                      63,289.50	$     66,710.50	$        566,184.50
12/31/22	$                                                                            130,000.00	$                      56,618.45	$     73,381.55	$        492,802.95
12/31/23	$                                                                            130,000.00	$                      49,280.30	$     80,719.71	$        412,083.25
12/31/24	$                                                                            130,000.00	$                      41,208.32	$     88,791.68	$        323,291.57
12/31/25	$                                                                            130,000.00	$                      32,329.16	$     97,670.84	$        225,620.73
12/31/26	$                                                                            130,000.00	$                      22,562.07	$   107,437.93	$        118,182.80
12/31/27	$                                                                            130,000.00	$                      11,818.28	$   118,182.80	$                  (0.00)
Total	$                                                                         1,040,000.00	$                    277,106.08	$   762,895.00