Assume that on January 1, 20X1, 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, 20X1, 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’s implicit rate of return on the lease is unknown.

Required:

1. Explain why Trans Global should account for the lease as a finance lease.

2. Make all journal entries that Trans Global would make related to the lease from 20X1 to 20X2 assuming that it is a finance lease. Round all amounts to the nearest dollar. Ignore journal entries required to classify amounts as current.

3. Prepare a schedule of the year-to-year and total (before-tax) income differences that would result from accounting for the lease as a finance lease versus an operating lease. Round all amounts to the nearest dollar.

4. Why might Trans Global’s managers prefer the lease to be accounted for as an operating lease rather than as a finance lease?