honeycfa

If a lease is treated as a finance lease, as compared to being treated as an operating lease, the effect on the lessee's current ratio and the debt/equity ratio will be an:

Current Ratio

Debt/Equity Ratio

A) Increase Increase

B) Decrease Increase

C) Increase Decrease

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With finance leases the lessee's assets, current liabilities, and long-term liabilities will be greater than if the lease was an operating lease. With the debt to equity ratio, the liability is in the numerator, which results in an increase in the ratio. With the current ratio, current liabilities are increased and are in the denominator which results in a decrease in the ratio.

honeycfa

Which of the following statements regarding finance and operating leases is least accurate?

A) During the life of an operating lease, the rent expense equals the lease payment.

B) For financial reporting of finance and operating leases, no entry is required on the lessee's balance sheet at the inception of the lease.

C) Asset turnover is higher for the lessee with an operating lease than a finance lease.

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If the lease is an operating lease there is no entry made on the balance sheet for the lessee. For finance leases, the leased asset and liability are recognized on the balance sheet by the amount equal to the present value of the minimum lease payments using as the discount rate the lower of the lessor's implicit rate or the lessee's incremental borrowing rate.

honeycfa

Which of the following statements about leases is least accurate?

A) In the first years of a finance lease, the lessee's debt to equity ratio is greater than it would have been if the firm had used an operating lease.

B) In the first years of a finance lease, the lessee's current ratio is greater than it would have been had the firm used an operating lease.

C) All else equal, when a lease is capitalized the lessee's income will rise over the term of the lease.

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From the lessee's perspective, if a lease is considered to be a finance lease instead of an operating lease, then the lessee's current liabilities will be greater until the lease has expired. This will result in a lower current ratio (larger denominator).

In the early years, the capitalized lease expense (interest plus depreciation) is greater than in the later years because interest expense decreases over time. Less expenses = more income.

In the first years of a finance lease the lessee's debt to equity ratio will be greater than if the firm had used an operating lease because in the case of the finance lease, the numerator is comprised of (debt + lease), while the numerator in the case of the operating lease is (debt) only. In addition, the greater capitalized lease expense flows through to decrease shareholder's equity (the denominator).

honeycfa

If a lessee enters into a finance lease rather than an operating lease, it can expect to have a:

A) higher return on assets.

B) lower debt-to-equity ratio.

C) higher debt-to-equity ratio.

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Leasing the asset with an operating lease avoids recognition of the debt on the lessee’s balance sheet. Having fewer assets and liabilities on the balance sheet than would exist if the assets were purchased increases profitability ratios (e.g., return on assets) and decreases leverage ratios (e.g., debt-to-equity ratio). In the case of a finance lease, the assets are reported on the balance sheet and are depreciated.

honeycfa

Which of the following statements that classify a lease as a finance lease under U.S. GAAP is least accurate?

A) Title is transferred at the end of the lease period.

B) The present value of the lease payments is at least 80% of the fair market value of the asset.

C) A bargain purchase option exists.

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For a lease to be classified as a finance (capital) lease the present value of the lease payments must be at least 90% of the fair market value of the asset.

honeycfa

The Mader Corporation leases an asset for five years with lease payments of $10,000 per year. If Mader classifies the lease as a finance lease, which financial statements are affected at the end of the first year?

A) Statement of cash flows, income statement, and balance sheet.

B) Income statement and balance sheet only.

C) Income statement only.

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The classification of a lease as a finance lease creates an asset, a debt obligation, financing cash flows (amortization of the loan), and operating cash flows (interest expense).

honeycfa

For a finance lease, the amount recorded initially by the lessee as a liability will:

A) equal the present value of the minimum lease payments at the beginning of the lease.

B) be less than the total of the minimum lease payments.

C) equal the total of the minimum lease payments.

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With a finance lease, both an asset and liability are reported on the lessee's balance sheet, with lease payments divided between interest and principal components. The future payments on principal and interest must be discounted to present value at the beginning of the lease.