Ford Motor Credit agrees to lease a Ford Mustang to Bullitt Detective Agency, Inc. on Jan. 1, 2015. The following information relates to the lease agreement.
1. The term of the lease is 3 years non-cancelable, with 2 renewal options of one year each. The car has an expected life of 8 years.
2. Bullitt's incremental borrowing rate is 5.5% apr. The implicit interest rate used by Ford is 4.3% apr and is known to Bullitt (after all, they are the best detective agency in San Francisco).
3. The cost of the car is $19,500, and the fair value of the Mustang on 1/1/2015 is $32,800.
4. At the end of the lease term, the Mustang reverts to Ford and has a guaranteed residual value of $4,000. Bullitt depreciates all of its cars on a sum-of-the-years basis because it knows that cars lose most of their value in the first few years.
5. A termination penalty assures renewal of the lease for a period of 1 year after the expiration of the lease.
6. An option allowing Bullitt to extend the lease beyond the last renewal is exercised by Bullitt (Why give a Mustang back sooner than you have to?)
7. The lease agreement requires equal 6-month payments beginning on Jan. 1, 2015.
8. Given the high probability of damaging a car leased to a detective agency, Ford decides to require Bullitt to purchase casualty insurance. The amount per 6 month's is $3000. The payment of the insurance is to be included in lease payment made every 6 months.
9. The collectability of the lease payments is reasonably predictable, and there is no important uncertainties surrounding the amount of costs to be incurred by the Ford.
Instructions
a. Tell me what kind of lease this is for both Bullitt and Ford. Be specific and give the reason why you think it is this type of lease.
b. Compute the present value of the minimum lease payments. (Hint: How do you handle the residual value?)
c. Calculate the amount of the total rental payment required.
d. Prepare a lease amortization for Bullitt using the guaranteed residual value for 2015 and 2016. (Do not include the executory costs in your lease amortization schedule.)
e. Prepare the journal entries Bullitt would make in 2015. Be sure to include any year end adjustments that need to be made.
f. Prepare the journal entries Ford would make in 2015.