andytrader

Which of the following statements about leases is least accurate?

A) 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.

B) 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.

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).

andytrader

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.

andytrader

Which of the following statements regarding the effect of a finance lease on the lessee's statement of cash flows is least accurate?

A) The rental expense serves to reduce the cash flow for financing because it is an investment expense.

B) The change in the finance lease liability on the balance sheet is a cash flow from financing.

C) The interest expense portion of the lease payments reduces cash flow from operations.

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In finance leases, there is only interest expense and principal repayment. Rental expense is only charged when the lease is an operating lease.

andytrader

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) Income statement and balance sheet only.

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

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).

andytrader

Which of the following statements regarding a direct financing lease is least accurate?

A) The principal portion of the lease payment is a cash inflow from investing on the lessor's cash flow statement.

B) The lessor recognizes no gross profit at the inception of the lease.

C) Interest revenue on the lessor's income statement equals the implicit interest rate times the lease payment.

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Interest revenues are calculated by multiplying the implicit interest rate by net receivables at the beginning of the period.

andytrader

Penguin Company is planning to lease a $5 million machine to produce goods for eventual sale. Penguin is able to structure the lease so as to classify it as either an operating or a finance lease. Advantages to Penguin of classifying this lease as an operating lease are least likely to include that:

A) no disclosures of payments due under the lease are required.

B) depreciation is not recorded.

C) the lease is not reported as debt on Penguin's balance sheet, so leverage ratios are not increased.

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Cash payments due under an operating lease must be disclosed in the notes to the financial statements for each of the following five years and in aggregate. Operating leases are simpler to account for and the often adverse ratio implications of offsetting increases in assets and liabilities are avoided.

andytrader

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

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

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

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.

andytrader

Classifying a lease as an operating lease for a lessee, as opposed to a finance lease, will result in:

Current Ratio

Debt/Equity Ratio

Asset Turnover Ratio

A) Higher Lower Higher

B) Higher Lower Lower

C) Lower Lower Higher

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For a lessee using operating leases, the current ratio will be higher, the debt/equity ratio will be lower, and the asset turnover will be higher than they would be with finance leases. With operating leases, assets and liabilities are lower.

andytrader

Which of the following is least likely disclosed in the financial statement footnotes of a lessee?

A) A general description of the leasing arrangement.

B) The lease payments to be paid in each of the next five years.

C) The lease interest rate.

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The interest rate used by the lessee is not a required disclosure.

clearlycanadian

In a defined contribution pension plan, investment risk is borne by the:

A) employee.

B) employer.

C) plan manager.

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In a defined contribution plan, the employee makes the investment decisions and assumes the investment risk.