On December 31, 20X1, Day Company leased a new machine from Parr with the following pertinent information:

Lease term ................................................................................................................... 5 years
Annual rental payable on December 31 (beginning December 31, 20X1) .......... $50,000
Useful life of machine ................................................................................................. 8 years
Day’s incremental borrowing rate ................................................................................. 15%
Implicit interest rate in lease (known by Day) .............................................................. 11%

The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr’s accounting records is $375,500.

Required:

1. Explain whether the lease will be an operating lease or a finance lease.

2. Compute the amount of Day’s lease liability at the beginning of the lease term assuming that the first payment has been made.