Operating/capital Leases Cfa Level 1

Front 1

Criteria for Capital Lease

Back 1

1. Title of leased asset is transferred at end of lease
2. Bargain purchase option exists
3. Lease period is 75% of asset life
4. PV of lease payments greater than 90% of assets economic value

Front 2

Criteria for Operating Lease

Back 2

Doesnt meet any of the 4 criteria for capital lease

Front 3

Capital lease characteristics

Back 3

Capital leases recognize both asset and liability on balance sheet. Leased asset is then depreciated on the income statement. Lease payment is separated into interest expense and principal payment and CFO is reduced by interest expense and CFF is reduced by principal payment

Front 4

Operating lease characterisics

Back 4

At inception of lease, no entry is made. Only rent expense (lease payment) is charged to income and CFO during life of lease

Front 5

Financial statement impact of Capital lease (compared to operating lease)

Back 5

Assets = Higher
Liabilities (current and long term) = Higher
NI (early years) = Lower
NI (later years) = Higher
Total NI = same
EBIT = Higher
CFO = Higher
CFF = Lower
Total CF = same

Front 6

Financial statement impact of operating lease (compared to capital lease)

Back 6

Assets = lower
Liabilities (current and long term) = lower
NI (early years) = Higher
NI (later years) = lower
Total NI = Same
EBIT = lower
CFO = Lower
CFF = Higher
Total CF = same

Front 7

Ratio impact of Capital lease (compared to operating lease)

Back 7

Current ratio = lower
working capital = lower
Asset turnover = lower
ROA = lower
ROE = lower
Debt/assets = higher
Debt/equity = higher

Front 8

Ratio impact of operating lease (compared to capital lease)

Back 8

Current ratio = higher
working capital = higher
Asset turnover = higher
ROA = higher
ROE = higher
Debt/assets = lower
Debt/equity = lower