The proposed lease agreement involves an aircraft that has a fair value of $1000000. This plane would be leased for a period of 10 years starting on 1 July 2010. The lease agreement agreement is cancellable only on accidental destruction of the plane. An annual lease payment of $141 780 is due on 1 July of each year starting on 1 July 2010. Maintenance operations are scheduled by the lessor, and Bluey Ltd will pay for these services. Estimated annual maintenance costs are $6900. The lessor will pay all insurance premiums and terminal fees, which amount to a combined total of $4000 annually and are included in the annual lease payment of $141780.
On expiration of the 10 year lease, Bluey Ltd can purchase the aircraft for $44440. The estimated useful life of the aircraft is 15 years, and its salvage value in the second hand market is estimated to be $100000 after 10 years. The salvage value probably will never be less than $75000 if the engines are overhauled and maintained as prescribed by the manufacturer. If the purchase option is not exercised possession of the plane will revert to the lessor, and there is no provision for renewing the lease agreement beyond its termination date.
Bluey Ltd can borrow $1000000 under a 10 year term loan agreement at an annual interest rate of 12%. The implicit interest rate in the lease is 8% based on ten net rental payments of $137780 per year and the initial market value of $1000000 for the plane. On 1 July 2010 the present value of all net rental payments and the purchase option of $44 440 is $888890 using the 12% interest rate. The present value of all net rental payments and the $44440 purchase option on 1 July 2010 is $1022226 using the 8% interest rate implicit in the lease agreement is a finance lease as defined in IAS 17.
a) What is the appropriate amount that Bluey Ltd should recognize for the leased aircraft on its statement of financial position as on 1st July 2010. State the reasons for your conclusion.
b) Assume that the annual lease payment is $141780 as stated in the question, that the appropriate capitalized amount for the leased aircraft is $1 000 000 on 1 July 2010 and that the implicit interest rate is 9%. Provide all the journal entries (narrations not required) that pertain to the lease for the year running from 1 July 2010 to 30 June 2011 and the journal entry to be made on 1 July 2011.
C) how will the lease be reported in the 30 June 2011 balance sheet and related income statement