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Security devices Inc. needs additional office space to accommodate expansion. SDI wants to avoid income statement...

Security devices Inc. needs additional office space to accommodate expansion. SDI wants to avoid income statement effects that would disrupt its attempt to “smooth” income over time. Which lease classification would management prefer? Explain.

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Ans: Here since Security devices Inc.’s management does not want to take hit over its income statement hence they should go for Capital lease instead of operating lease, since operating lease are used basically for short term period and here the ownership does not get passed to the lessee it remains with lessor and a regular lease payments has to be made from lessee (Security devices Inc.) towards lessor and this payments has to be considered as operative in nature and thus has to be expensed out in income statement. Thus it will be a hit in income statement.

On the other hand in capital lease, it is basically used for longer period and ownership gets transferred towards the end of the lease period to lessee and also it is realized as debt and bear interests which are expensed out. Interest quantum would be much lower than the regular lease payments hence less impact in income statement. Also the leased assets are booked in assets side and they get the depreciation which is not cash item. In simple term a capital lease is nothing but a purchase of the assets. Hence, it is balance sheet item.

SO here Security devices Inc. should go for capital lease.

ekkarill92 answered 1 year ago
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