Rand Medical manufactures lithotripters. Lithotripsy uses shock waves instead of surgery to eliminate kidney stones. Physicians' Leasing purchased a lithotripter from Rand for $2,000,000 and leased it to Mid-South Urologists Group, Inc., on January 1, 2011.

Lease Description:

Quarterly rental payments .............$130,516 - beginning of each period
Lease term ............................5 yrs. (20 qtrs)
No residual value; no BPO
Economic life of lithotripter .........5 yrs
Implicit interest rate & lessee's incremental borrowing rate ..................................12%
Fair value of asset ...................$2,000,000

Collectibility of the lease payments is reasonably assured, and there are no lessor costs yet to be incurred.

Required:

1. How should this lease be classified by Mid-South Urologists Group and by Physicians' Leasing?

2. Prepare appropriate entries for both Mid-South Urologists Group and Physicians' Leasing from the inception of the lease through the second rental payment on April 1, 2011. Depreciation is recorded at the end of each fiscal year (December 31).

3. Assume Mid-South Urologists Group leased the lithotripter directly from the manufacturer, Rand Medical, which produced the machine at a cost of $1.7 million. Prepare appropriate entries for Rand Medical from the inception of the lease through the second lease payment on April 1, 2011.