As compared to an operating lease, which of the following best describes the impact of a capital lease on earnings before interest and taxes (EBIT) and operating cash flow (OCF) according to U.S. generally accepted accounting principles? EBIT OCF A) Higher Higher B) Higher Lower C) Lower Higher D) Lower Lower Your answer: C was incorrect. The correct answer was A) Higher Higher With an operating lease, rent expense is included in EBIT. In a capital lease, rent expense is replaced by depreciation expense and interest expense. Since EBIT is calculated before interest and taxes, EBIT is higher with a capital lease. In an operating lease, the rent payment is included in operating cash flow. With a capital lease, the rent payment is replaced by principal and interest. Since principal payments are considered financing activities, operating cash flow is higher with a capital lease. I am just not able to think at the moment, so this might seem a very stupid question. I am confused here becuz I thot EBIT would be higher with an operating lease because then you didn’t account for any depreciation right? I mean…EBIT comes after DA, so in a capital lease, the DA would be subtracted, while in an operating lease, there’s no DA which means its higher innit?
For an operating lease, you have a lease expense. That is all. Lets assume your lease expense is $5,000. If you have a capital lease for the same asset, your payment is approximately the same. But now you have a $5,000 payment broken down into interest and depreciation. EBIT is before interest so instead of a full $5,000 expense, you are only deducting the depreciation part in a capital lease.
ur saving my life today wcfa…
No problem…better to get this stuff now, rather than freaking out the week before the test.
I think this is more L1 stuff… good to know though.