Part 1

The Lilliput Transport Authority (LTA) provides public transport services in a major metro-politan area. On October 1, 2019, it entered a deal with Bus Finance Co. (BFC) to lease 100 new buses with the following terms: 

■ Lease term is 9 years. 

■ Useful life is 13 years. 

■ Executory (maintenance) costs for each bus are $1,500 per year and are to be included as part of the lease payment. 

■ Unguaranteed residual value at the end of the lease term is $14,500 per bus. 

■ By the end of the contract, the bus fleet reverts to BFC. 

■ Estimated residual value, end of useful life, is $3,600 per bus. 

■ BFC’s interest rate implicit in the lease is 9%, which is known by LTA and the same as LTA’s incremental borrowing rate. 

■ Each bus sells for $60,000. BFC only leases the fleet of buses and is not a bus manufacturer. 

■ Annual lease and maintenance payments are made on October 1 of each year, with the first payment made on the inception date. 

■ LTA, which has a December 31 year end, is a private firm that elects to account for its financial results in accordance with ASPE. 

Required:

a. Calculate the annual payment required by BFC. 

b. Explain how LTA would classify this lease. 

c. Independent of your answer to part (b), assume this is a finance lease for both companies. Prepare all required journal entries for BFC for 2019. 

d. Independent of your answer to part (b), assume this is a finance lease for both companies. Prepare all required journal entries for LTA for 2019.

Part 2 

LTA also entered into a deal with Swift Transport Inc. to lease new cars for its metro system. The LTA metro cars use a wheel technology. Most rubber-tired trains, including the one used by LTA, are purpose-built and designed for the system on which they operate. The terms of the deal are the following: 

■ Lease term is eight years. 

■ Useful life is 20 years. 

■ Unguaranteed residual value at the end of the lease term is $500,000 per car. 

■ By the end of the contract, the cars revert to Swift Transport. 

■ Estimated salvage value, end of useful life, is $0. 

■ Swift Transport’s interest rate implicit in the lease is 7% and this is known by LTA. LTA’s incremental borrowing rate is 9%. 

■ Each car sells for $1,000,000. 

■ Annual lease payment of $110,966 per car and maintenance payment of $25,000 per car are made on October 1 of each year, with the first payment made on the inception date. 

Required:

Discuss how LTA would classify this lease.