Xavier Corp. leases equipment with a useful life of ten years to Zero Inc. The operating lease requires annual payments of $1,500 over a three-year period without a renewal option. After two years, the two companies agree to extend a lease term by two years and increase annual payments to $1,750. What should happen because of this lease modification?

 Multiple Choice

1. Both companies should treat the original lease as being terminated and account for the modification as a new lease. 

2. The lease should be reclassified from an operating lease to a finance/sales-type lease. 

3. What has been recorded by both companies must be adjusted to conform to the new terms of the contract. 

4. All the answer choices are correct.