Question

If a firm uses operating leases in order to keep their actions off of the balance sheet, then how will the following financial statement items and ratios be affected? (Note that this is the opposite of the revisions that you just made. You went from having leases to not having leases while this is asking what would happen if you had leases).

COGS                                                                    Increase                               Decrease

Depreciation                                                      Increase                               Decrease

Interest Expense                                              Increase                               Decrease

Fixed Assets                                                       Increase                               Decrease

Long Term Debt                                                Increase                               Decrease

Why would a company try to classify leases as Operating Leases instead of capital leases in order to finance their operations?

Answer 1

Answer Part 1

Particular	Increase / Decrease	Reason
COGS	Increase	Under opereating lease , the lease expenses are treated as cash flow from operations thus its as operating expense which increases the COGS
Depreciation	Decrease	Operating Lease does not impact balance sheet , thus no assets are recorded in the books which decreses the overall depreciation expense.
Interest Expense	Decrease	As lease expense under operating lease is in form of rentals thus there is no interest expense in case of operating lease.
Fixed Assets	Decrease	Operating Lease does not impact balance sheet , thus no fixed assets is recorded
Long Term Debt	Decrease	Operating Lease does not impact balance sheet , thus no long term debt is generated.

Answer Part 2

Company try to classify leases as Operating Leases instead of capital leases in order to finance their operations due to the following reasons :

• Operating Leases is an off balance sheet transaction where as capital leases creates a capital obligation ie it is increases debt.
• Capital lease increases the debt portion that means it deteriorate the debt equity ratio.Thus it give limited asses to other loans.
• Tax deduction unders capital lesase cannot be claim on the lumsum cost of capital lease ie tax decuctions work as a depreciation thus tax benifit is spread through out the life of lease.