Bunker Company negotiated a lease with Gilbreth Company that begins on January 1, 2014. The lease term is three years, and the asset’s economic life is four years. 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%.
1. Determine whether Bunker must treat this lease as an operating lease or a capital lease.
2. Prepare an amortization table for the lease.
3. Prepare Bunker’s journal entries for the first two years of the lease.
4. Assume that all facts remain the same except that the asset’s useful life is six years. Is this an operating lease or a capital lease? Prepare journal entries for the first two years of the lease.
5. Compare the financial statement effects of the lease treatment you selected in requirement 3 with the financial statement effects of the treatment you selected in requirement 4. Specifically, compare the effects on assets, liabilities, and equity under the two alternative sets of assumptions as of December 31, 2014, immediately after the first lease payment is made.