so, I think it is the case that the D/E ratio would be higher if the lease of a long-lived asset is classifie as a financing lease as opposed to operating?
I think the reason is because of the added liabilities (PV of the future debt mayments). But my question is- isn’t equity higher under a financing lease? Does’t the asset get transferrred to the leesee’s balance sheet, therefore the lessee’s balance sheet would see a higher equity level (because of the added leased asset)?
Thanks,
and sorry- what about ROA as well? Asset level is higher for a leseee under a financing lease, so ROA would be lower? But is the numerator (NI) the same in this ratio regardless of weather we call it financing or operating?
thnx
If you buy an asset with cash, then cash account decreases and fixed assets account increase by the same amount. Net impact = 0, so equity does not change.
If you buy an asset with debt, then fixed assets account increase and on the side of liabilities long-term debt increases by the same amount. Net impact = 0, so equity does not change.
If you buy an asset by finance leasing, the case is exactly the same as above, so equity does not change.
Equity part of BS only moves when issued new stocks, stock buy backs, retained earnings increase or minority interests appears when the company adquire competitors. If you buy a pencil for you company, it does not change equity unless you issue new shares to purchase the pencil.
Hope this helps.
Yep. That’s why companies prefer operating leases, they appear more “profitable”.
Not necessarily. When you account for operating lease, the operating lease expense goes on income statement, commonly a fixed payment, say 80. This is like paying rent over a borrowed asset.
When you account for finance lease, on the other hand, you assume the asset on your BS, so you must depreciate the asset (not necessarily in straight line) so the depreciation expense goes to IS. Also you must account for interest expense on IS. Commonly, interest expense is not equal all periods, it is high at the beginning and low at the end of the lease.
Summing up, NI is likely to be different under both type of leases. NI is commonly lower under finance lease than under operating lease at the first years of the deal to revert the figure at the end of the life of the deal.
Hope this helps!
soo helpful yes! i always try and separate cash and inventory from equity for some reason…
You are welcome 