Unformatted text preview: of Lease Payments =
= Automobiles (+A) $10,000 per Car 100 Cars x Present Value of an
Ordinary Annuity Factor for i = 10%, n = 5
$1,000,000 3.7908 from Table 5 in Appendix A
Lease Liability (+L)
3,790,800 Leased automobiles.
c. Interest Expense Depreciation Expense Total Rental Expense d. = Lease Obligation 10%
= $3,790,800 10%
= Cost of Automobiles ÷ 5 Years
$3,790,800 ÷ 5
$758,160 = Interest Expense + Depreciation Expense
= $379,080 + $758,160
= $1,137,240 Classifying the lease as an operating lease would give rise to both higher net income and a lower
debt/equity ratio. By classifying the lease as an operating lease, net income would be reduced during
2011 by $1,000,000 [from part (a)] for rent expense. Alternatively, classifying the lease as a capital lease
would reduce net income by a total of $1,137,240 [from part (c)] for the interest expense associated with
the lease and for the depreciation associated with the capitalized asset.
Future obligations under operating leases are not disclosed in a company's financial statements as a liability. Consequently, an operating lease would not affect a company's total liabilities. On the other hand,
the present values of future lease obligations are reported as liabilities under capital leases, which means
that a capital lease results in increased liabilities compared to an operating lease. In addition, the
differential effect of capital and operating leases on net income will affect total stockholders' equity through
Retained Earnings. Specifically, the balance in Retained Earnings, and thus total stockholders' equity, will
be higher by classifying the lease as an operating lease as opposed to classifying it as a capital lease.
Therefore, Tradeall's total liabilities would be lower and its stockholders' equity higher if the lease were
classified as an operating lease rather than as a capital lease. This means that classifying the lease as an
operating lease would yield a lower debt/equity ratio. E11–23 Concluded
e. Offbalance sheet financing...
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- Fall '08