Financial Accounting Methods For The Lessee And Lessor

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Leases are “an agreement conveying the right to use property, plant and equipment (PP&E) usually for a stated period of time” according the Financial Accounting Standard Board (FASB) statement number 13. There are different types of leases which have various standards that govern the classification for the lessee and lessor. Each lease is classified based on some general criteria questions; however all leases involve a lessee, a lessor, and a contractual agreement. The accounting method for each lease has different methods.
A lease encompasses a lessee, “user of a leased asset,” (Spiceland, Sepe & Nelson, p.G-4) and a lessor, “owner of a leased asset,” (Spiceland, Sepe & Nelson, p.G-4) coming to an agreement which substantiates the lessor
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However, the lessee of a capital lease reports the cash flows for payments towards interest expense as cash flows from operating activities and reports the payments toward the principal as cash flows from financing activities. Whereas, the lessor reports cash flows from the interest portion as cash flows from operating activities and the cash receipts toward the principal portion as cash flows from investing activities. Another difference is the accounting for the statement of cash flows has the entire lease payment as rent under the operating lease, which is an outflow of operating cash. Whereas, the capital lease has an outflow of any operating cash and the principal paid is an outflow of financing cash. Under the capital lease, it has more expenditure in the early years for expenses, the taxable income is lower, and the operating cash outflow is lower as well. The capital lease cash flow is much higher in the early years due to these expenses. Some of the other differences are: Effect of Operating Lease Effect of Capitalized Lease
Return on Capital • Decreases earnings before interest
• Rate of change increases • Decreases earnings before interest because of depreciation
• Capital increases due to the present value of the operating lease and Rate of change is lower
Interest Coverage • Interest expense is not affected
• Coverage ratio is generally higher • Interest expense increases
• Coverage ratio is generally lower
Debt Ratio • Debt is usually not affected
• Debt ratio is lower • Debt increases
• Debt ratio is

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