On January 1, 2007 the Stimpson Company sells land to Barker Company for $2.5 million, then immediately leases it back. The relevant information is as follows:

1. The land was carried on Stimpson’s books at a value of $2 million.

2. The term of the non-cancelable lease is 25 years.

3. The lease agreement requires equal rental payments of $357,007 at the end of each year.

4. The incremental borrowing rate of Stimpson Company is 15%. Stimpson is aware that Barker Company set the annual rental to ensure a rate of return of 14%.

5. The land has a fair value of $2.5 million on January 1, 2007.

6. Stimpson Company has the option of purchasing the land for $150 at the end of 25 years.

7. Stimpson Company pays all executory costs. These costs consist of insurance and property taxes amounting to $12,000 per year.

8. There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor, and the collectibility of the rentals is reasonably assured.

Required

1. Prepare the journal entries for the seller-lessee, Stimpson, for 2007 to reflect the sale and leaseback agreement. In calculating the present value of the lease payments, ignore the $150 bargain purchase option as immaterial.

2. Describe briefly the accounting treatment of the gain by the seller-lessee.