Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2021, Rhone-Metro leased equipment to Western Soya Co. for a noncancelable stated lease term of four years ending December 31, 2025, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost $300,000 to manufacture and has an expected useful life of six years. Its normal sales price is $375,898. The expected residual value of $17,000 at December 31, 2025, is not guaranteed. Western Soya Co. is reasonably certain to exercise a purchase option on December 30, 2024, at an option price of $8,000. Equal payments under the lease are $140,000 (including $6,000 annual maintenance costs) and are due on December 31 of each year. The first payment was made on December 31, 2021. Western Soya's incremental borrowing rate is 10%. Western Soya knows the interest rate implicit in the lease payments is 9%. Both companies use straight-line amortization.

Hint: A lease term ends for accounting purposes when an option becomes exercisable if it's to be exercised (i.e., a BPO).

Required:

1. Show how Rhone-Metro calculated the $140,000 annual lease payments.

2. How should this lease be classified (a) by western Soya Co. (the lessee) and (b) by Rhone-Metro Industries (the lessor)?

3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2021.