Question 1 - Operating lease; scheduled rent increases
On January 1, 2011, Sweetwater Furniture Company leased office space under a 21-year operating lease agreement. The contract calls for annual rent payments on December 31 of each year. The payments are $10,000 the first year and increase by $500 per year. Benefits expected from using the office space are expected to remain constant over the lease term.
Required: Record Sweetwater's rent payment at December 31, 2015 (the fifth rent payment) and December 31, 2025 (the 15th rent payment).
Question 2 - Capital lease
At the beginning of 2011, VHF Industries acquired a machine with a fair value of $6,074,700 by signing a four-year lease. The lease is payable in four annual payments of $2 million at the end of each year.
Required:
1. What is the effective rate of interest implicit in the agreement?
2. Prepare the lessee's journal entry at the inception of the lease.
3. Prepare the journal entry to record the first lease payment at December 31, 2011.
4. Prepare the journal entry to record the second lease payment at December 31, 2012.
5. Suppose the fair value of the machine and the lessor's implicit rate were unknown at the time of the lease, but that the lessee's incremental borrowing rate of interest for notes of similar risk was 11%. Prepare the lessee's entry at the inception of the lease.
Question 3 - Initial direct costs; direct financing lease
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:
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)?
2. Prepare the appropriate entries for both Red Baron Flying Club and Bidwell Leasing on January 1, 2011.
3. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Red Baron Flying Club.
4. Determine the effective rate of interest for Bidwell Leasing for the purpose of recognizing interest revenue over the lease term.
5. Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Bidwell Leasing.
6. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2011 (the second lease payment). Both companies use straight-line depreciation.
7. Prepare the appropriate entries for both Red Baron and Bidwell Leasing on December 31, 2017 (the final lease payment).