On January 1, 2007 the Alice Company leases electronic equipment for five years, agreeing to pay $70,000 annually at the beginning of each year under the non-cancelable lease. Superior Electronics Company, the lessor, agrees to pay all executory costs, estimated to be $3,450 per year. The cost and also fair value of the equipment is $500,000. Its estimated life is 10 years. The estimated residual value at the end of five years is $200,000; at the end of 10 years, it is $5,000. There is no bargain purchase option in the lease nor any agreement to transfer ownership at the end of the lease to the lessee. The lessee’s incremental borrowing rate is 12%. During 2007 Superior Electronics pays property taxes of $650, maintenance costs of $1,600, and insurance of $1,200. There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor. Straight-line depreciation is considered the appropriate method by both companies.

Required

1. Identify the type of lease involved for Alice Company and Superior Electronics Company and give reasons for your classifications.

2. Prepare appropriate journal entries for 2007 for the lessee and lessor.