Question

Leasing is often referred to as off-balance-sheet financing because of the way that the transaction is treated and reported in financial statements. According to the FASB-issued Statement 13, which of the following statements is true?
A. Assets leased under financial or capital leases should be reported as fixed assets on the balance sheet.
B. Leased assets should be reported as current assets on the balance sheet.
C. The present value of all future lease payments should be reported as a liability on the balance sheet.
D. The present value of all past lease payments should be reported as assets on the balance sheet.
Consider the following statement on capital leases:
According to Statement 13, the payments on a financial lease should be treated as an operating expense and should not in any case affect a firm's true debt ratio. Is the preceding statement true or false?
a. True
b. False
To consider the financial statement effects of leasing versus purchasing an asset, review the following case of Shoe Building Inc.
Shoe Building Inc. needs equipment that will cost the company $800. Shoe Building Inc is considering to either purchase the equipment by borrowing $800 from a local bank or leasing the equipment. Assume that the lease will be structured as an operating lease. Some data from Shoe Building Inc.'s current balance sheet prior to the lease or purchase of the equipment are:_____.
1. The company's current debt ratio is _____.
2. If the company purchases the equipment by taking a loan, the total debt in the balance sheet will _____, and the debt ratio will change to _____.
3. If the company leases the equipment, the company's debt ratio will _____ because the lease is not capitalized.
4. In this case, the company's financial risk will be _____ under a lease agreement as compared to the financial risk in purchasing the equipment by taking a loan.
5. However, if the lease is capitalized, the financial risk under the lease agreement will be _____ as compared to the risk in buying the equipment.

Answer 1

Solution :

Part 1

a). According to the$\text{ FASB-issued statement}$ 13 :

The Assets that are leased under the capital leases or the financial should be reported as the fixed assets on balance sheet.

b). False, the payments on the financial lease should not be treated as the operating expense.

Part 2

1. The debt ratio = $\frac{2400}{6000}$

                           = 0.40

2. The total debt in the balance sheet is 2400 + 800 = $ 3200 whereas debt ratio will change to 0.4706

3. Debt ratio of the company will remain same as the lease will not be capitalized.

4. The financial risk of the company will be less under the the lease agreement as compared $\text{to the financial risk in purchasing the equipment }$ by taking the loan.

5. However, when lease is capitalized, financial risk under lease agreement will remain same as $\text{compared to the risk in buying the equipment.}$