capital and operating leases

when do capital lease, both asset and liability will increase, are they increase the same amount? why net income for capital lease is lower than operating lease in earlier years, and opposite in later years? thanks. for capital lease, net income will be lower, also working capital (equity) will be lower too. the ROE will be lower also. How quantify in this case, ROE is always lower compare to operating lease? Thanks.

Net income is lower for a capital lease because the lease expense is higher than with an operating lease in the early years. The reason lease expense is higher under a capital lease is because it is comprised of two items: interest expense and depreciation. These amounts may well sum to an amount greater than the cash lease payment, especially if accelerated depreciation is used. Only the cash lease payment is less expense in an operating lease. In later years, depreciation is lower so lease expense may be lower under a capital lease than an operating lease. ROE is lower for a capital lease in the early years because net income, the numerator in ROE, is lower.

yes, the liablity and asset will be increase at the same time and same amount to make balance sheet balance, it’s like DR Lease Asset xxx CR Lease Liability xxx because capital lease will include interest expense and depreciation expense, so in the earlier year, the interest expense is high due to the high principle, which makes the total expense higher than operating lease, but later year it will reverse, operating lease payout is constant WORKING CAPITAL=CA-CL, when CL increase, the working capital will decrease. ROE=R/E, when equity doesn’t change, return decrease in capital lease, make the ROE decrease

A increases and L decreases by the Exact same amount to balance the B.S. Lease Expense(CL) = Interest Expense + Deprecaition Lease Expense(OL) = Rent Interest Expense = constant Initial Years -------------- As Assets are high in Capital Lease, and if we use Acc Depr, DE is high, so NI is low in early years Lease Expense(CL) > Lease Expense(OL) Later Years --------------- Lease Expense(CL) < Lease Expense(OL) ROE = NI/E --> NI low in early years --> ROE low in early years