On January 1, 2007 the Orr Company sells heavy equipment to Foible Company for $3 million, then immediately leases it back. The relevant information is as follows:

The lease is non-cancelable and has a term of eight years. The annual rentals are $603,908.50, payable at the end of each year. The seller-lessee agrees to pay all executory costs. The interest rate implicit in the lease is 12%. The cost of the heavy equipment to Orr Company is $2,100,000. The purchaser-lessor incurs no material initial direct costs. The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor.

Orr’s incremental borrowing rate is 12% and the company estimates that the economic life of the equipment is eight years. The present value on January 1, 2007 of eight payments of $603,908.50, discounted at 12%, is $3 million ($603,908.50 _ 4.967640). The executory costs for 2007 are:

Repairs and maintenance .....$10,200

Property taxes .........20,500

Insurance ..........18,000

Required

1. What type of lease is this to the seller-lessee? Discuss.

2. Prepare the journal entries for both the seller-lessee and the purchaser-lessor for 2007 to reflect the sale and leaseback agreement. Assume that the company uses the straight-line depreciation method.