David Smith, CFA, suspects that a particular company’s interest coverage ration may be overstated compared to that of other companies in the same industry and therefore requires additional adjustment. If the company is a lessee and meanwhile inventory prices and quantities have been decreasing, the accounting methods used for new lease commitments and inventory valuations respectively that are most likely to have overstated the interest coverage ration are: A: Capital leases and FIFO B: Capital leases and LIFO C: Operating leases and FIFO D: Operating leases and LIFO hope u like it
inventory quantities and prices decreasing -> EBIT overstated by LIFO interest coverage ratio overstated -> less interest expense -> operating lease my guess is D
B Interest coverage =EBIT/Interest payments Capital leases have lower Int payments and higher EBIT (but NI is lower) Decreasing price environment LIFO will overstate EBIT
capital leases have lower interest payments? i was under the impression operating leases have -zero- interest payments
I agree with D
cap leases have higher Interest payments then operating because operating only has rent expense
I’d say D Capital leases overestimates EBIT because only depreciation is taken out as SG&A (under operating leases, the entire rent gets expensed). BUT, at much higher IE, a capital lease has a lower EBIT/IE than an operating lease. Decreasing prices, some inventory liquidation, LIFO is still going to underestimate COGS, overestimating gross profit.
You are right sharp, D
B Either EBIT is overstated or Int. Exp. is understated. Capital leases have less int. exp since they have some partitioned to principle. LIFO will overstate EBIT because ***IT IS A DECREASING PRICE ENVIRONMENT***
i’m starting to feel better about leases, though i’m still not completely sure about the balance sheet treatment for both lessee and lessor
And I am feeling bad for mixing rent expense and interest expense. Hope I am careful in exam. I am done with readings, so there is nothing more I can do at this point.
congrat Sharp ! here is another one According to IAS 17, when a company sells property and then leases it back, any gain on the sale should usually be: A. recognized in the current year. B. recognized as a prior period adjustment. C. recognized at the end of the lease. D. deferred and recognized as income over the term of the lease
I would guess A good q though
that’s D if the lease back is capital, or A if it is operational I think.
Although, I remember that under IAS17, if the asset leased back is highly customized for the needs of the lessee, it should be treated as a capital lease.
ok map !! ur correct again
so answer is d?
Thats, A. if you anticipate a gain, you recognize it right away, since you are the lessor.
nice, thanks, i had no idea about that second one
got it right! yay