XYZ Corporation signed a lease agreement with ABC Company on January 1, 2016 to lease new equipment. The non-cancelable lease has a term of 10 years. There are no purchase or renewal options. XYZ should make the annual lease payment of $70,000 at the end of each year.

The fair value of the equipment at the inception of the lease is $540,521.45. The equipment has an economic life of 15 years. The lease term does not include a guaranteed residual value. The cost of the equipment to ABC Company is $500,000. XYZ Corporation must pay executory costs of general maintenance expenses related to the lease of $1,000 per year on December 31 of each year.

XYZ depreciates the equipment its currently owns on a straight-line basis.XYZ Corporations incremental borrowing rate is 6% and the ABC 5% implicit rate in the lease is known to XYC Corporation. There no material uncertainties as to collection of the lease payments or future costs to be incurred under the lease.

Required:

Classify the lease agreement for both the lessee and the lessor. Justify your answer.

Prepare the lessees journal entries required for the first year of the lease term. Show all supporting calculations for the journal entries.

Prepare the lessors journal entries required for the first year of the lease term. Show all supporting calculations for the journal entries.