Plash Photo Company leased a digital reproduction machine on January 1, 2022. The following information was obtained from the lease contract:
• The lease carries a term of 5 years. There is no renewal option and there is no transfer of ownership.
• The rental payments of $120,000 per year are due each January 1 with the first payment due at lease commencement.
• The fair value of the equipment on the date the lease is signed is $650,000. The equipment has an economic life of 8 years. The lessor paid fair value to acquire the asset. On January 1, 2022, the carrying value is $650,000.

• There is a guaranteed residual value of $100,000 provided by a third party. This guaranteed residual value is equal to the expected residual value so that there is no unguaranteed residual asset expected at the end of the lease term.

• Plash Photo depreciates similar machinery that it owns on a straight-line basis.

• The lessee pays initial direct costs of $10,000 at the lease commencement date.

• Plash Photo’s incremental borrowing rate is 10% per year. Plash does not know the lessor’s implicit rate.

• The lessor is reasonably certain regarding the collection of the lease payments, and it is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee.

Required

a. Classify the lease for both the lessor and the lessee. Find the lessor’s implicit rate.

b. Prepare the journal entries for Plash Photo (the lessee) for the first year of the lease (i.e., January 1 and December 31).

c. Prepare the journal entries for the lessor for the first year of the lease (i.e., January 1 and December 31).