usually prefer operating lease than capitalize it, if capitalize it, will increase liability and asset the same, but increase net income. if keep it as operating lease, then it will reduce net income. is that right? when see a footnote on B/S and I/S, how should we adjust it? Thanks.
operating lease increases net income in the early years because the lease payment is less than the depreciation and interest expense recorded on the income statement for capital leases. remember the cash flows will be the same. so the cash paid for each type of lease is the same. to go from capital to operating: 1. remove the asset/ depreciation expense from the balance sheet and the income statement, respectively 2. remove the interest expense and put the total cash paid in operating expenses. to go from operating to capital just do the reverse. add the asset, depreciation and interest expense to the balance sheet and income statement.
yes, BaySt. is correct, remember an operating lease is just a rental, while a capital lease you actually own the CAPITAL ASSET (think long-term). Companies love operating leases b/c they are off balance sheet so they improve leverage ratios.
I am reading on this topic as well and have some question as well. Can you please elaborate on how finance lease lowers the current ratio, working capital, and leverage? For current ratio, is it because finance lease is recorded as PP&E whereas the liability is in current liability? Thus, CA/CL is lowered? I guess that same logic applies for Working capital right? As for leverage, how does debt/assets change when we are inputting asset/liability by the same amount to begin w/? Please help, thank you!
I think I might have figured this out, it’s because there’s a liability (long term debt) plus a current liability (lease obligation for the period). Is that right guys?
Re debt/assets ratio, this is a tricky one because a finance lease will affect numerator AND denominator…however the % change to debt is normally higher (because companies normally have less debt than assets) so you would expect the ratio to typically get higher (ie, worse). hope that helps
makes sense. thank you very much Kiakaha.
finance/capital leases do not lower leverage, they increase it