Question

What is are the impact of lease capitalisation on financial statement and key ratios according to journal written by Karen wong and mahesh Joshi?

Answer 1

The impact of lease capitalization on the financial statement and key ratios according to a journal written by Karen Wong and Mahesh Joshi can be explained under two categories-

1.  Impact of lease capitalization on the financial statement-According to the journal, the increase in total liabilities is higher compared to total assets. This is attributed to greater depreciation on leased assets compared to lease payments in the earlier stage of the lease term.

Lease accounting on reported numbers in the Balance Sheet are stated as follows:

a) Lease capitalization, as proposed in the ED on lease accounting, has a significant impact on total assets, total liabilities, and total equity recorded in the Balance Sheet

b) Lease capitalization, as proposed in the ED on lease accounting, has a greater impact on total liabilities than total assets recorded in the Balance Sheet

2.  Impact of lease capitalization on key ratios-The financial ratios are central data for all stakeholders. ED on lease accounting will have an impact on financial ratios through changes in the ‘bottom-line’ financial statement numbers. It can be explained as follows-

a) Leverage (gearing) ratios- Leverage ratios such as D/E, D/A ratios are the common measurements used to evaluate the liquidity of the companies and to understand the financing method of the companies. Most of the prior studies have focused on the lease capitalization effect on leverage ratios and have documented the significance of the changes in the selected ratios.

b)) Debt to assets (D/A)- The impact of lease capitalization on the debt to assets (D/A) ratio for companies, engaged in the transportation (airlines) and FMCG (grocery) industries. Both selected industries are high in operating lease usage. It is found that the lease capitalization will increase the D/A ratio for both groups of companies. It means -

b.1) The D/E ratio and D/A ratio will increase for both positive and negative income subgroups.

b.2)  The ROA will decrease for companies with negative income-earning and increase for companies with positive income earning.

Finally, it can be said that there is significant impact of lease capitalization on the financial statement and key ratios.

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