Discussion week 7

Discussion week 7 - Operating Lease Method- Under this...

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As we have learned from the discussions and course materials, it is very important for a company’s financial statement to present the best possible scenario to stakeholders and analysts. With that in mind we can understand why a company would be interested in presenting a balance sheet with the lowest levels of debt possible. One way to achieve this off balance sheet financing is through a contract arrangement between the party that owns an asset and the party interested in using the asset. This contract is known as a lease (Easton, Halsey, McAnally, Hartgraves, & Morse, 2010) . GAAP identifies two different types of methods by which a lease can be reported: Capital Lease Method - With this method the lease asset as well as its liability should appear on the balance sheet. The asset shows depreciation as a long term asset would show, the liability shows amortization as debt and the payments are separated into expenses (interest expense and principal repayment) (Easton et al, 2010).
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Unformatted text preview: Operating Lease Method- Under this method the lease asset and the lease liability are not reported on the balance sheet. The payments for the lease are reflected as rent expense when paid. (Easton et al, 2010) The difference between the two methods should be taken into consideration depending on the companys purpose. For example, under the capital lease method NOPAT is higher, greater operating cash flows are reported. Under the operating lease method, NOAT is higher, balance sheet measures of financial leverage are improved, the perceived quality of the companys ROE is improved and the net income reflected during the early years of the lease is higher than with the capital lease method (Easton et al, 2010). References: Easton, P. D., Halsey, R. F., McAnally, M. L., Hartgraves, A. & Morse, W. J., (2010). Financial & Managerial Accounting for MBAs. Canada: Cambridge Business Publishers, LLC....
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