Financial Reporting and Analysis【 Reading 21】Sample 2004, statements, 2012

invic

Selected information from Yorktown Corp.’s financial statements for the year ended December 31, 2004 was as follows (in $ millions):

Accounts Payable	8
Long-term Debt	9
Common Stock	17
Retained Earnings	23
Total Liabilities & Equity	57

In 2004, Yorktown paid $10 million cash to purchase a franchise.  The franchise cost was fully expensed in 2004.  If the company had elected to amortize the franchise cost over 5 years instead of expensing it, Yorktown’s total debt ratio (total debt-to-total capital) would (ignore taxes):

A) decrease from 0.298 to 0.262.

B) increase from 0.474 to 0.551.

C) decrease from 0.474 to 0.403.

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Total capital equals total assets which must equal total liabilities and equity. Yorktown’s total debt ratio was (($8 + $9) / $57 =) 0.298. If the franchise cost were amortized, retained earnings would be increased $8 million ($10 cost less ($10 / 5 =) $2 million of amortization.) The total debt ratio would change to (($8 + $9) / ($57 + $8) =) 0.262.

bapswarrior

In a direct-financing lease, the implicit rate is such that the present value of the minimum lease payments:

A) equals the cost of the leased asset.

B) equals the sale price of the leased asset.

C) is lower than the cost of the leased asset.

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In a direct-financing lease, the implicit rate is such that the present value of the MLPs equals the cost of the leased asset. Thus, at lease inception the total assets do not change and no gain is recognized.

bapswarrior

An analyst compares two companies that are identical except that Company X uses finance leases and Company Y uses operating leases. The analyst would expect Company X’s debt-to-equity ratio, relative to Company Y’s, to be:

A) lower.

B) higher.

C) the same.

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Lease capitalization adds both current and noncurrent liabilities to debt, resulting in a corresponding increase in the debt-to-equity and other leverage ratios. Thus, Company X’s (Debt + Lease)/Equity is greater than Company Y’s Debt/Equity.

bapswarrior

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 Lower

B) Higher Lower Higher

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.

bapswarrior

Compared to an operating lease, a lessee using a finance lease is least likely to have:

A) higher cash flow from financing during the lease period.

B) a lower current ratio.

C) lower net income in the earlier years of the lease.

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Since a portion of the lease payment is treated as repayment of principal under a finance lease, cash flow from financing will be lower.

bapswarrior

Under an operating lease (versus a finance lease) which of the following is higher for the lessee?

A) Cash flow from financing.

B) Cash flow from operations.

C) Assets.

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The lessee's cash flows from financing will be higher for an operating lease because the payments made for an operating lease are operating cash outflows, not financing cash outflows. The payments made under a finance lease are split between interest paid and principal. The latter is charged to cash flow from financing

bapswarrior

On the lessee's cash flow statement, the principal portion of a finance lease payment is a:

A) operating cash flow.

B) investing cash flow.

C) financing cash flow.

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The principal portion of a finance lease payment is a financing cash outflow for the lessee. The interest portion is an operating cash outflow.

bapswarrior

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) Decrease Increase

B) Increase 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.

JonnyKay

For a given lease payment and term, which of the following is least accurate regarding the effects of the classification of the lease as a finance lease as compared to an operating lease?

A) The lessee's asset turnover will be lower for a finance lease.

B) The lessee's current ratio will be higher for a finance lease.

C) The lessee's debt-to-equity ratio will be higher for a finance lease.

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The lessee's current ratio will be lower because the current portion of the finance lease increases current liabilities, hence reducing the current ratio.

JonnyKay

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

A) higher debt-to-equity ratio.

B) higher return on assets.

C) lower 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.