Capitalizing-costs firm => higher early year profitability (as long as the expenditures growth is positive) but ROA and ROE can be higher or lower than expensing-cost firm (Reading 36, LOS a) Capitalized leases => lower early year profitability, lower ROA and ROE in the early year than operating leases (Reading 40, LOS b) Is this true? I don’t understand why they are different
Capitalize vs Expensing: When a firm capitalizes, it treats the value as an asset (CFI); when a firm expenses, it treats it as an expense in the income statement, therefore lower net income. Capitalizing Lease vs Operating Lease: For an operating lease, a firm has rental expense; For a capitalized lease, it has depreciation + interest expense (which equals coupon + amort), therefore more expense, less net income.
-Capitalization - Both assets and liabilities (current and long-term ones) in the balance sheet increase, working capital decreases, but the debt/equity ratio increases, creating additional leverage. -Expensing - lease obligations are not recognized; therefore, leverage ratios are understated and ROE and ROA are overstated.