On January 1, 2010, the Ballieu Company leases specialty equipment with an economic life of eight years to the Anderson Company. The lease contains the following terms and provisions: The lease is noncancelable and has a term of eight years. The annual rentals are $35,000, payable at the beginning of each year. The interest rate implicit in the lease is 14%. The Anderson Company agrees to pay all executory costs and is given an option to buy the equipment for $1 at the end of the lease term, December 31, 2017.

The cost of the equipment to the lessor is $150,000 and the fair retail value is approximately $185,100. The lessor incurs no material initial direct costs. The collectability of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor. The lessor estimates that the fair value is expected to be significantly greater than $1 at the end of the lease term. The lessor calculates that the present value on January 1, 2010 of eight annual payments in advance of $35,000 discounted at 14% is $185,090.68 (the $1 purchase option is ignored as immaterial).

Required

1. Identify the classification of the lease transaction from the point of view of Ballieu Company. Give the reasons for your classification.

2. Prepare all the journal entries for Ballieu Company for the years 2010 and 2011.

3. Discuss the disclosure requirements for the lease transaction in the notes to the financial statements of the Ballieu Company.