A heavy equipment manufacturer provides some equipment to a customer through a leasing arrangement and classifies the lease as an operating lease. Compared with classifying the lease as a financing lease, the manufacturer’s financial statements will most likely show:
a lower amount of total financial assets.
lower revenues in future years.
a higher debt-to-equity ratio.
why 1 is wrong? this is the explanation provided but i cannot understand it.
A is incorrect because with financing lease treatment, a large long-term receivable (a financial asset) is set up to recognize the present value of the future payments owed to the lessor. This long-term receivable is much larger than the operating lease receivables, which amount to just one year’s worth of lease payments.
Some question have a “deeper meaning” and you are right that answer may look ambigous lessor/lessee. Look at the operating lease as an off balance sheet source of financing. many companies does that even in curriculum there should be a large paragraph how to adjust for that.
In operating lease arrangement lessor continues to report the leased asset on the B/S and depreciation expense on the income statement from that asset - this is purely Tangible Fixed Assets subject to depreciation, they are not financial assets. So manufacturer just rent them.Think operational lease as associated with lessor operations business model - He produces them own them and you as a customer may just rent it but don’t own it. And to compare financial position adjustments must be made to operational leases.