Interstate Automobiles Corporation leased 40 vans to VIP
Transport under a four-year noncancelable lease
on January 1, 2016. Information concerning the lease and the vans follows:
a.
Equal annual lease
payments of $300,000 are due on January 1, 2016, and thereafter on December
31 each year. The first payment was made January 1, 2016. Interstate’s implicit interest rate is 10% and known
by VIP.
b.
VIP has the option
to purchase all of the vans at the end of the lease for a total of $290,000.
The vans’ estimated residual value is $300,000 at the end of the lease term
and $50,000 at the end of 7 years, the estimated life of each van.
c.
VIP estimates the
fair value of the vans to be $1,240,000. Interstate’s cost
was $1,050,000.
d.
VIP’s incremental borrowing rate is 11%.
e.
VIP will pay
the executory costs (maintenance, insurance, and other
fees not included in the annual lease payments) of $1,000 per year. The
depreciation method is straight-line.
f.
The collectability of the lease payments is reasonably
predictable, and there are no important cost uncertainties.
Required:
a.
Identify potential
advantages to VIP of leasing the vans rather than purchasing them.
b.
How should the lease
be classified by VIP? by Interstate?
c.
Regardless of your
response to previous requirements, suppose VIP recorded the lease on January
1, 2016, as a capital lease in the amount of $1,100,000. What would be the
appropriate journal entries related to the capital lease for the second lease
payment on December 31, 2016?
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