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Reading 38: Long-Term Liabilities and Leases - LOS f ~ Q1-4

Q1. 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)   depreciation is not recorded.

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

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

Q2. The lessee has an incentive to classify a lease as an operating lease, rather than as a finance lease, because an operating lease:

A)   has no risk involved because the lessor assumes all risk.

B)   has payments that are less than a capital lease's payments.

C)   does not appear on the balance sheet.

Q3. A lessee most likely has an incentive to structure a lease as an operating lease rather than a finance lease when it:

A)   has a high debt-to-equity ratio.

B)   does not have debt covenants.

C)   is very profitable.

Q4. Compared to a finance lease, an operating lease is most likely to be favored when:

A)   management compensation is not based on returns on invested capital.

B)   at the end of the lease, the lessee may be better able to sell the asset than the lessor.

C)   the lessee has bond covenants relating to financial policies.

答案和详解如下:

Q1. 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)   depreciation is not recorded.

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

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

Correct answer is C)         

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.

Q2. The lessee has an incentive to classify a lease as an operating lease, rather than as a finance lease, because an operating lease:

A)   has no risk involved because the lessor assumes all risk.

B)   has payments that are less than a capital lease's payments.

C)   does not appear on the balance sheet.

Correct answer is C)         

Having less assets and liabilities on the balance sheet than would exist if the asset were purchased increases profitability ratios (e.g., return on assets) and decreases leverage ratios (e.g., the debt to equity ratio).

Q3. A lessee most likely has an incentive to structure a lease as an operating lease rather than a finance lease when it:

A)   has a high debt-to-equity ratio.

B)   does not have debt covenants.

C)   is very profitable.

Correct answer is A)

A firm with a high debt-to-equity ratio is more likely to use an operating lease instead of a capital lease. Use of an operating lease avoids the recognition of debt on the lessee’s balance sheet and will not increase the debt-to-equity ratio.

Q4. Compared to a finance lease, an operating lease is most likely to be favored when:

A)   management compensation is not based on returns on invested capital.

B)   at the end of the lease, the lessee may be better able to sell the asset than the lessor.

C)   the lessee has bond covenants relating to financial policies.

Correct answer is C)         

If the lessee has bond covenants (e.g., debt-to-equity ratio) relating to its financial policies that it must follow, it is best to have an operating lease due to the fact that the operating lease will keep the asset off of the balance sheet resulting in less liabilities.

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