 # capital leases

why under a capital lease is the debt/asset ratio higher compard to a operating lease? i thought that under a cap lease both debt and equity are increased… so if they are both increased by the same vale doesnt this ratio decrease? especially since assets are higher?

typo… i thought under a cap lease both debt and assets were increased… so how is the debt to asset ratio increased?

Because although they both rise in absolute terms ie \$100000, in relative terms the increase in the numerator is less than that in the denominator and as such the ratio rises

geno is right! Debt < Asset (if it’s not obvious use E + L = A, Debt is a liability, equity positive) if both Debt is increased by delta, then Asset will increase by delta. (Debt + delta)/(Asset + delta) - Asset/Debt = (Asset-Debt)*delta/[Asset*(Asset + delta)] > 0 the ratio has increased.

Geno, Don’t you mean, in relative terms the increase in the numerator is GREATER than that in the denominator, and as such the ratio rises…?

Is this the forum to audition for the show “Are you smarter than a 5th grader”? Try playing with some numbers. Take the ratio 1/5 or 20% Add 3 to the numerator and denominator. You get 4/8 or 50%. The ratio goes up. Best of luck with derivatives.

I don’t think there are many fifth graders who know much about capital leases. Maybe you did when you were a fifth grader, but that’s just not normal.

thats not a very nice comment Super I

My point was more about being able to quickly figure out the answer to the question, what happens to a ratio that is less than one when you add equal amounts to the numerator and denominator, not about the complexity of opertaing vs cap lease rules. Sorry about the derivatives comment, but after a few posts dancing around figuring out the answer to the original question, I thought a shock of cold water was needed. There are going to be MANY situations on L1 where you get asked about a concept and the simplest way to approach it is to stick some simple make believe numbers on paper and adjust them in some way to see how ratios, balance sheet vs income statement vs cash flow, etc. relationships change. You need to learn to be able to quickly identify those situations and crank thru them.

thanks guys now i understand… i was just doing it in my head and made a mistake… from now on i am going to use numbers and adjust them…

now i can understand another thing i was trying to figure out… under a cap lease the lessor will have a higher turnover ratio… asset turnover ratio = net sales/ assets initially i was only looking at assets increasing and thinking that this ratio should adjust downward… 1/10 = .10 sales will increase under a cap lease from the lessor point of view as well… if both increase by 3 4/13= .30 so the ratio adjust up… now i got it… thanks everyone…

Can someone differentiate the accounting ledgers of lessor and leassee in terms of capital lease and operating lease? For leasee, capital lease requires to recognize asset (which is leased) and the debt commitments as debt. Operating lease requires recognition of lease expense only. How about leasor accounting?

lessor accounting i hate… confuses me…

How about my question above, everybody? Anyone mind clarifying? Thanks.