To get better economic measures of earnings power, it is said we should eliminate non-recurring sources from income statement, e.g. discontinued operations. But in case of balance sheet, it is said some recurring items needs adjusting, e.g. capitalizing operational leases. Shouldn’t be adjusted both financial statements the same way? Specially considering capitalizing operational leases will affect income accounts. Need some help please.
operational leases - you have rental expense on the income statement, but nothing shows up on the balance sheet. (This is the Off-Balance Sheet financing). If you compared companies that had a whole host of operational leases vs. a company that had capitalized leases - you are going to see a whole host of differences between the financial statements and the two would not be an apples-to-apples comparison. Hence the right way is to bring back the operational leases into the balance sheet - introduce the Capitalized lease assets, the Capitalized lease liabilities using the present value of lease obligations, etc. etc. (Level 1 stuff) which makes the financial statements and ratios comparable.
Fine, but once the assets are increased, it would also be necessary to adjust income statement, to add the interest extra-expense which is present only under capitalizated leases circumstances. Income normalization formula doesn’t mention this adjustment, only non-recurring items they say.
extract from Schweser: operating Income uses capital lease is higher than it uses operating lease, cos interest income is not included in calculation of operating income, under operating lease, the entire payment is subtracted. Lease payment includes interest expense and depreciation in both captal & operating lease. for operating lease, to arrive operating income (EBIT) entire amount of payment is subtracted. for capital lease, to arrive EBIT, depreciation amount is subtracted. Anyone please correct me, if my understanding is not making sense.