Question: Assume that on January 1 2014 Trans Global Airlines leases

Assume that on January 1, 2014, Trans Global Airlines leases two used Boeing 737s from Aircraft Lessors Inc. The eight-year lease calls for payments of $10,000,000 at each year-end. On January 1, 2014, the Boeing 737s have a total fair value of $60,000,000 and a remaining useful life of 11 years. Assume that Trans Global’s incremental borrowing rate is 9% and that it uses straight-line depreciation for financial reporting purposes. The lease is noncancelable, and Trans Global cannot renew it. In addition, there is no bargain purchase option, and ownership of the leased asset reverts to Aircraft Lessors at the end of the lease. Aircraft Lessors’ implicit rate of return on the lease is unknown.

1. Should Trans Global account for the lease as a capital or an operating lease? Why?
2. Based on your answer to requirement 1, make all journal entries that Trans Global would make related to the lease for 2014, 2015, 2016, and 2017. Round all amounts to the nearest dollar.
3. Assume that Trans Global accounts for the lease using whichever method (capital or operating) that you did not select in requirement 1. Make all journal entries related to the lease for 2014, 2015, 2016, and 2017.
4. Prepare a schedule of the year-to-year and total (before-tax) income differences that would result from accounting for the lease as a capital lease versus an operating lease. Round all amounts to the nearest dollar.
5. Why might Trans Global’s managers prefer the lease to be accounted for as an operating
lease rather than as a capital lease?

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  • CreatedSeptember 10, 2014
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