Boeing builds a plane for $10 million that it normally sells for $15 million. However, on January 1, 20X0, Boeing leases this plane to Delta for $3 million per year for 7 years (the entire expected life of the plane). The present value of the future lease payments equals $17.35 million. Which of the following answers is correct?*2 pointsTo Boeing, this lease qualifies as a direct financing lease.To Delta, this lease qualifies as a sales type leaseBoeing will recognize a $5 million profit when the lease is signed.Delta recognizes rent expense of $3 million in 20X0.
Question
Boeing builds a plane for 15 million. However, on January 1, 20X0, Boeing leases this plane to Delta for 17.35 million. Which of the following answers is correct?*2 pointsTo Boeing, this lease qualifies as a direct financing lease.To Delta, this lease qualifies as a sales type leaseBoeing will recognize a 3 million in 20X0.
Solution
The correct answer is: "To Boeing, this lease qualifies as a direct financing lease."
Here's why:
A lease is considered a direct financing lease when the lessor's only source of revenue is interest. The lessor (Boeing in this case) is not a manufacturer or dealer. The cost of the plane to Boeing is 17.35 million. This means that Boeing is earning interest on the lease, but is not making a profit from the sale of the plane itself. Therefore, this lease qualifies as a direct financing lease for Boeing.
The other options are incorrect because:
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To Delta, this lease does not qualify as a sales type lease. A sales type lease is one where the lessor (Boeing) is a manufacturer or dealer and earns a profit from the sale of the asset. In this case, Boeing is not earning a profit from the sale of the plane, so it's not a sales type lease for Delta.
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Boeing will not recognize a $5 million profit when the lease is signed. The profit on a lease is recognized over the life of the lease, not at the time the lease is signed. Plus, in this case, Boeing is not making a profit from the sale of the plane.
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Delta does not recognize rent expense of $3 million in 20X0. The rent expense is recognized over the life of the lease, not in the year the lease is signed.
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