Crown Auto leased 40 vans to Piedmont Transport under a four-year noncancelable lease on January, 1, 2016. Information concerning the lease and the vans follows:
a. Equal annual lease payments of $200,000 are due on January 1, 2016 and thereafter on December 31 each year. The first payment was made on January 1, 2016. Crown Auto’s implicit interest rate is 10% and is known by Piedmont.
b. Piedmont has the option to purchase all of the vans at the end of the lease for a total of $200,000 minus $10,000. The vans’ estimated residual value is $200,000 at the end of the lease term and $50,000 at the end of 7 years, the estimated life of each van.
c. Crown Auto estimates the fair value of the vans to be $ (4 *20) + 40,000. Piedmont’s cost was three and one half times the lease payment
d. Piedmont’s incremental borrowing rate is 11%.
e. Piedmont will pay the executory costs (maintenance, insurance, and other fees not included in the annual lease payments) of $1,000 per year. The depreciation method is straight-line.
f. The collectability of the lease payments is reasonably predictable and there are no important cost uncertainties.
Required: 1. What are the potential advantages to Piedmont of leasing the vans rather than purchasing them? Are there any tax advantages?
2. How should the lease be classified by Crown Auto and by Piedmont?
3. Suppose Crown Auto recorded the lease on January 1, 2016, as a capital lease in the amount of $1,100,000. What would be the appropriate journal entries related to the capital lease for the second lease payment on December 31, 2016?
4. Suppose the lease is a capital lease. Prepare an amortization table for 7 years.