How do you guys rem the effect on ROA and ROE for the foll Capitalizing and Expensing Straight line v/s Accelerated depreciation Capital v/s Operating lease - I think this should be similar to Capitalizing v/s Expensing.
With capitalizing and expensing you know that capitalizing will create smoother income- that is look at it almost as a flat line Then expensing will create low roa and roe at beginning since you deduct all in the first year. But overall both lead to same results so the expensing ‘line’ starts lower and ends higher that that of capitalizing. i use basically same method for straight line and accelerated depreciation
actually capital/operating lease is the exact opposite of capitalize/expensing in terms of roa roe.
In capital lease and capitalizing, wont the assets increase.?
yes they would but the result is not the same it really is all about how much they increase think in relative terms for example for capitalizing interest is a small portion of the assets but a relatively big comparison to net income in capital leases the assets you add on the balance sheet are big in comparison to total versus the expense that you incurre with the lease payment(operating) since usually they are for long term
Let us consider the foll cases In case we capitalize a construction cost of real estate, assets will increase by a large amount. At the same time NI will decrease bcoz of depreciation of the asset. Similarly now we enter in a capital lease in which we adjust both the asset and liability by the PV of MLP. In this case too, we wil need to ammortize the liability which will decrease NI How will we work out ROA for both the cases
for the first example you do not capitalize the building… . you have the building either way expensing or not… the element that is expensed or capitalized is the interest incurred that means you have to leave amortization out of it because it impacts both now the interest expense for a building worth 40 mil might be a big amount to deduct out of the income of just one year… but the amount of interest capitalized to the whole value of the building is not much as a percentage so capitalizing creates a higher roa at first versus expensing for the lease its different because now you add to assets the present value of all the payments… that will increase the assets a lot. you still have to deduct depreciation and interest but now you have bigger assets on the other hand you deduct the lease payment but the net income is relative to lower assets
SORRY WAS CONFUSED… DELETED MY POST… CP
Yes that makes sense. WE need to see the relative amt added to assets and the amt decuted from NI.
THat is exactly the opp of what florinpop said. I am confused
I just confirmed with Schweser. Florinpop is right. ROA and ROE higher initially for CApitalizing ROA lower for CApital leases
Florin is right… sorry about my post. I am going to remove that post… to not confuse others.
One more ting guys. I have posted this in other posts too. I just gave this exam Level 1 version 3 Exam v5. This is exam 3 rt?
CPK, that is incorrect. In capital expense ROA & ROE will be greater in early years because NI goes up by a greater % than assets/equity. in capital lease ROA & ROE will be lower in earlier years because total capital expense (dep +interest) >operating expense in earlier years. The main difference here, is that with capital lease your NI actually goes down in the early years.
Let me take another shot. CAPITAL LEASE: when you capitalize a lease – Assets go up by a huge amount = PV(MLP). You are deducting both Interest expense and depreciation expense to arrive at the NI figure. At the same time, the Total Assets has also gone up. So in the initial years of a capital lease - the ROA would be lower. Over time the ROA increases as earnings trend is positive, and assets tend to decrease over time. In the case of an Operating Lease --> in the early years, no assets are recorded, and NI would be higher than in a capital lease - because the Interest expense + depreciation expense on the capital lease would be greater than the operating lease expense (which is the rental expense). So ROA in an operating lease would be higher. CAPITALIZED EXPENSE Earnings are higher % wise when compared to the increased asset value. So ROA would be higher.
Capitalize expenses cause Return of Equity/Asset to be higher in the early years. how are the BS accounts affected by capitalizing expenses? I know for CAPITALIZE LEASE, A and L would go up. Current lliabilities will go up too.