On January $1,2024,$ Marlon$$s Transport leased a car from Lopez Motors for a six$-$year period with an option to extend the lease for three years. Assume that the useful life of the car is $10$ years, and its cost is $$30,000.$ Marlon$$s had no significant economic incentive as of the beginning of the lease to exercise the $3-$year extension option. Annual lease payments are $$5,000$ due on December $31$ of each year, calculated by the lessor using a $5\%$ discount rate.

Assume that at the beginning of the third year, January $1,2026,$ Marlon$$s had made significant improvements to the car whose cost could be recovered only if it exercises the extension option, creating an expectation that extension of the lease was $$reasonably certain.$$ The relevant interest rate at that time was $6\%.$

Required:

$1.$ How would the lessee and lessor classify the lease before and after January $1,2026?$

Justify your classifications.

$2.$ Prepare the journal entries for the lessee and lessor from lease initiation through

December $31,2025.$

$3.$ Prepare the journal entry, if any, for $2026$ for the lessee to account for the reassessment.

$4.$ Prepare the journal entry, if any, for $2026$ for the lessor to account for the reassessment