Jennifer Lewis enters into a lease agreement with Craig Smith LLC to lease a piece of machinery for a four-year term. The lease terms specify annual payments of $2,885,915 at the end of each year with a present value of lease payments of $10 million using an interest rate of 6%. Any lease asset would be amortized over the four-year lease term. The machine will be returned to the lessor at the end of the lease term with no option to purchase the asset. The market value of the asset is $12 million.

Problem 1

What type of lease is this, operating or finance?

Problem 2

What amount of total lease expense will be recognized in the first year of the lease?