Reference no: EM133688
Bluey Ltd is a diversified company with nationwide interests in real estate, mining, finance and metal fabrication. The company has offices and locations in major cities all through Australia. Corporate headquarters for Bluey Ltd are located in Perth, and executives connected with several phases of company operations travel extensively. Corporate management is presently evaluating the feasibility of acquiring a business aircraft that will be used by company executives to expedite business travel to areas not adequately served by commercial airlines. Proposals for either purchasing or leasing a suitable aircraft have been analysed, and the leasing proposal was considered to be more desirable.
The proposed lease agreement involves an aircraft that has a fair value of $1000000. This plane could 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 Bluey and lessor Ltd will pay for these services. Evaluated annual maintenance costs are $6900. The lessor may pay all insurance premiums and terminal fees, which amount to a combined total of $4000 annually and are added in the annual lease payment of $141780.
On expiration of the 10 year lease, Bluey Ltd can buy the aircraft for $44440. The estimated useful life of the aircraft is 15 years, and its salvage value in the second hand market is evaluated to be $100000 after 10 years. The salvage value probably can 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 may 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 percent. The implicit interest rate in the lease is 8 percent 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 current value of all net rental payments and the purchase option of $44 440 is $888890 using the 12percent interest rate. The present value of all net rental payments and the $44440 purchase option on 1 July 2010 is $1022226 using the 8percent interest rate implicit in the lease agreement is a finance lease as defined in IAS 17.
Required
a) What is the suitable amount that Bluey Ltd should identify for the leased aircraft on its statement of financial position as on 1st July 2010. State the reasons for your conclusion.
b) Consider that the annual lease payment is $141780 as stated in the question, that the suitable capitalized amount for the leased aircraft is $1 000 000 on 1 July 2010 and that the implicit interest rate is 9%. Give all the journal entries (narrations not required) that pertain to the lease for the year running from 1st July 2010 to 30 June 2011 and the journal entry to be made on 1 July 2011.
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