Please clarify, why for balance adjustment purposes we should capitalize operating lease??? This is Op lease not cap lease. Leasee just periodically have to charge op lease expenses - and that’s all!!
You don’t do this to ALL operating leases. Notice that if a company leases an apartment for a relocating employee for 2 months, that’s a valid operating lease. If a company leases a building for 999 years (nice move Aurthur Guinness), you can call it an operating lease, but it behaves an awful lot like a capital lease because: - It represents a future obligation of rent payments (a liability) - It represents the future use of some piece of property which will presumably help the company earn a return (an asset)
bcos an operating lease is off balance sheet. when it comes on the balance sheet thro; the adjustments process - both an asset and a liability are brought on the balance sheet. rental expense on the income statement is removed, replaced by additional depreciation expense + interest expense. this reduces the NI in the initial portions of the lease life - bcos depr + int expense > rent expense. so ROA, ROE would be affected. Assets and liabilities increase - so Debt / Equity Leverage would change. this makes a lot of difference to how you might potentially view the company during your valuations.