Bunker Company negotiated a lease with Gilbreth Company that begins on January 1, 20X1. The lease term is three years, and the asset’s economic life is five years. The equipment was customized, and it would be of little use to the lessor at the end of the lease. The annual lease payments are $7,500, payable at the end of the year. The cost and fair value of the asset are $23,000. The lessee’s cost of borrowing is 9%.

Required:

1. Explain why Bunker must treat this lease as a finance lease. Consider each of the five lease criteria.

2. Prepare an amortization table for the lease.

3. Prepare Bunker’s journal entries for the first two years of the lease. You may ignore the journal entries needed to reclassify the current portion of the lease obligation.

4. Assume that the lease does not meet any of the finance lease criteria. Prepare the journal entries that would be necessary for operating lease treatment for the first two years of the lease. You may ignore the journal entries needed to reclassify the current portion of the lease obligation.

5. Compare the financial statement effects of the journal entries made in requirements 3 and 4. Specifically, compare the effects on assets, liabilities, and shareholders’ equity under the two approaches as of December 31, 20X1, immediately after the lease payment is made.