III. Operating Lease / Direct Financing Lease

On January 1, 2019, Parker Mfg Inc. leased a widget machine from Equipment Supply Corporation (ESC). The noncancelable lease agreement specifies four annual payments of $100,000 beginning January 1, 2019, the inception of the lease, and at each January 1 through 2022. ESC purchased the machine for cash on January 1, 2019 for its fair value of $499,271. The useful life of the widget machine is estimated to be six years. The appropriate interest rate for this transaction is 8%. The lease contains a third party residual value guarantee of $192,592. Additionally, the collectibility of the lease payments and any amounts due under a residual value guarantee is probable.

Required:

(1) How should the lease be classified by the lessee and the lessor?

(2) Prepare the entries for the lessee and the lessor at (a) the inception of the lease and (b) at the end of the first year.