Solve the below problem:
Q: Bidwell Leasing purchased a single-engine plane for its fair value of $645,526 and leased it to Red Baron Flying Club on January 1, 2011.
Terms of the lease agreement and related facts were:
a. Eight annual payments of $110,000 beginning January 1, 2011, the inception of the lease, and at each December 31 through 2017. Bidwell Leasing's implicit interest rate was 10%. The estimated useful life of the plane is eight years. Payments were calculated as follows:
Amount to be recovered (fair market value) $ 645,526
Lease payments at the beginning
of each of the next eight years: ($645,526 Af· 5.86842*) $ 110,000
Present value of an annuity due of $1: n = 8, i = 10%.
b. Red Baron's incremental borrowing rate is 11%.
c. Costs of negotiating and consummating the completed lease transaction incurred by Bidwell Leasing were $18,099.
d. Collectibility of the lease payments by Bidwell Leasing is reasonably predictable and there are no costs to the lessor that are yet to be incurred.
Required:
(1) How should this lease be classified (a) by Bidwell Leasing (the lessor) and (b) by Red Baron (the lessee)?
(a) Since at least one (two in this case) classification criterion and both additional lessor conditions are met, this is adirect financing leasecapital lease to the lessor (Bidwell Leasing). Since the fair value is the lessor's cost, there is no dealer's profit, making this a capital leasedirect financing lease.
(b) Since at least one (two in this case) criterion is met, this is a capital leasedirect financing lease to the lessee. Red Baron records the present value of minimum lease payments as a leased asset and a lease liability.