Leverage Ratios for Finance Lease. note, liability, something, increase

studyn

Page 267 on Schweser note for the explanation of the effect of Finance lease on leverage ratios, states that:
“Most importantly, leverage ratios such as debt to asset ratios and debt to equity ratio, will be higher with finance leases than operating leases”
Can someone explain why this is the case?  Since liability and asset increase by the same amount on the balance sheet for Finance leases, I will expect the debt to asset ratio to remain unchanged, which is not the case, there’s something I’m not getting here.

scr879

Imagine a company with Assets = 100, Equity = 60 and Liabilities = 40. If the company were to lease an additional asset worth 10 under an operating lease agreement, neither the asset itself nor a liability would be recognised and the leverage ratios which Schweser mention would stand at:
Debt/Assets = 40/100 = 0.4, and
Debt/Equity = 40/60 = 0.67
If the same asset (worth 10) were leased under a finance lease agreement, the balance sheet effect would be to increase assets and liabilities by 10 resulting in: Assets = 110, Equity = 60 (no change) and Debt = 50. The adjusted leverage ratios would be:
Debt/Assets = 50/110 = 0.45, and
Debt/Equity = 50/60 = 0.83
… so both have gone up.
Hope this helps

Penny-wenny

Good explanation, thanks!!!!