Question

From the lessee’s perspective, finance leases and operating leases are a little different. In the earlier years of a lease,

Select one: a. operating leases will cause income to be higher, compared to finance leases

b. finance leases will enable the lessee to report higher income, compared to operating leases.

c. finance leases will cause debt to be higher, compared to operating leases

d. operating leases will cause debt to be higher, compared to finance leases

Answer 1

The correct answer is option C -In the earlier years of a lease, Finance leases will cause debt to be higher, compared to operating lease because

1. Reported amount of assets and debts are higher in finance lease (full loan amount which is the net present value of all future payments is shown in the liability side)
2. Expenses are also higher in early years

Explanation for incorrect answer for option A - Lease payments are considered as operating expenses and are shown in income statement as expense which will reduce income. Hence, the statement is wrong.

Explanation for incorrect answer for option B - In finance lease,interest payments are expensed on the income statement as the lease is considered as a loan. Hence, the statement is wrong.

Explanation for incorrect answer for option D -Operating leases are treated as expenses and considered as off balance sheet items. Hence, the statement is wrong.