International Financial Reporting Standards_guide.pdf

Chapter 14 Leases (IAS 17) 159
TABLE 14.3 Effect of Operating and Finance Leases on Lessee Financial Statements and Key Financial Ratios
Item or ratio Operating lease Finance lease
Statement of
Financial Position
Statement of
Comprehensive
Income
Statement of Cash
Flows
Profit Margin
Asset Turnover
Current Ratio
Debt-to-Equity Ratio
Return on Assets
Return on Equity
Interest Coverage
No effects because no assets or liabilities
are created under the operating lease
method.
The lease payment is recorded as an
expense. These payments are often
constant over the life of the lease.
The entire cash outflow paid on the
lease is recorded as an operating cash
outflow.
Higher in the early years because the
rental expense is normally less than
the total expense reported under the
finance lease method.
However, in later years, it will be lower
than under the finance lease method.
Higher because there are no leased
assets recorded under the operating
lease method.
Higher because no short-term debt is
added to the Statement of Financial
Position by the operating lease method.
Lower because the operating lease
method creates no debt.
Higher in the early years because profits
are higher and assets are lower.
Higher in the early years because
earnings are higher.
Higher because no interest expense
occurs under the operating lease
method.
A leased asset (equipment) and a lease obligation are created when
the lease is recorded. Over the life of the lease, both are written off,
but the asset is usually written down faster, creating a net liability
during the life of the lease.
Both interest expense and depreciation expense are created. In the
early years of the lease, they combine to produce a higher expense
than is reported under the operating method. However, over the life
of the lease, the interest expense declines, causing the total expense
trend to decline. This produces a positive trend in earnings. In the
later years, earnings are higher under the finance lease method than
under the operating lease method.
Over the entire term of the lease, the total lease expenses are the
same under both methods.
The cash outflow from the lease payments is allocated partly to an
operating or financing cash outflow (interest expense) and partly
to a financing cash outflow (repayment of the lease obligation
principal).
The depreciation of the leased asset is not a cash expense and,
therefore, is not a cash flow item.
Lower in the early years because the total reported expense
under the finance lease method is normally higher than the lease
payment. However, the profit margin will trend upward over time,
so in the later years it will exceed that of the operating lease
method.
Lower because of the leased asset (equipment) that is created
under the finance lease method.
The ratio rises over time as the asset is depreciated.
Lower because the current portion of the lease obligation created
under the finance lease method is a current liability.
The current ratio falls farther over time as the current portion of the
lease obligation rises.
Higher because the finance lease method creates a lease
obligation liability (which is higher than the leased asset in the
early years).
However, the debt-to equity ratio decreases over time as the lease
obligation decreases.
Lower in the early years because earnings are lower and assets are
higher.
However, the return on asset ratio rises over time because the
earnings trend is positive and the assets decline as they are
depreciated.
Lower in the early years because earnings are lower.
However, the return on equity rises over time because of a positive
earnings trend.
Lower because interest expense is created by the finance lease
method.
However, the interest-coverage ratio rises over time because the
interest expense declines over time.