Hi guys,
I’m reviewing the leasing the material but get confused about this point “ROE of Finance leasing is supposed to be lower than Operating leasing’s in early years”. I just cannot rationale this one. Why is that? The net income is lower if we use Financing leasing. However, the equity using finance lease is going to reduce by a bigger amount, isn’t it?. My reason: (depreciation expense + interest expense) > lease payment and both of these sides is accounted in Equity.
Can someone make it clear for me? I’m struggle with this leasing material a lot 
One of my best guess for this is that we have an interest payable account so the equity of finance leasing only account for the depreciation expense. But what if we pay the lease payment at the beginning? it’s still the same confusion at above
Cheers
Suppose that net income is lower by $10, and that that’s a 10% change in net income.
It’s likely a 1% change (or less) in equity. Recall that equity includes all of the accumulated net income for the last hundred years, plus contributed capital; it should be a lot bigger than any one year’s net income.
Hi there, thank you so much for your reply. I’m afraid you misunderstand my question. I get the point of why ROE using finance lease will be lower. I just don’t understand why it will be even lower than the ROE using operation leasing. Or do you mean the difference between two method’s equity is so small that only the change of net income matter?
Yes: the (percentage) difference in equity is so small that only the difference in net income matters.
Hi there,
I have seen similar question like above and just have and just wondering if you can please help.
Q. Company A and B acquired the same long-lived asset with A capitalised it and B expensed it. Company A will show higher:
A) net income than B
B) working capital than B
C) investing cash flow than B
as nampham stated above, I believe company A has lower net income as it have to serve the interest expense…
Am I missing some bit here or is the question wrong?
The answer is A btw… thanks in advance!
Hi elfship,
The answer will be A. Let say the cost which we are considering between capitalising and expense equals 300. The period of capitalising is 3 years. If we expense it, the whole value of 300 will be accounted in the current year. If we capitalise the cost, only 100 will be accounted in the current year => capitalising cost will give you higher net income in early year
oh… right…
I see what it is now… thank you and good luck in the exam!
