Question

Explain the difference between operating and financing liabilities. In addition, discuss the implications of lease accounting for the analysis of financial statements.

Answer 1

Accounting for Operating lease:

Balance Sheet: Neither a liability nor an asset is reported.

Income Statement: The asset’s rent which is similar as the lease payment is expensed.

Cash Flow Statement: The complete the rent expenditure or lease payment is reported as operating cash outflow.

Accounting for Financial:

Balance Sheet: Both leased asset as well as lease payable (liability) is reported. The reported value is lower of the present value of the leased asset’s fair market value or the lease payments in future.

Income Statement: The expense of interest on the lease payable is reported. It is computed on the lease payable at the beginning using the implied interest rate in the lease. If the leased asset is depreciable, then depreciation expenditure can be reported as well with any other asset.

Cash Flow Statement: The interest component of the lease payment under U.S.GAAP is reported as an operating cash outflow.

The implications of lease accounting for the analysis of financial statements are as follows:

--Liabilities, Assets, net income in later years, operating income (EBIT) and cash flow from operations are higher in finance lease in comparison to operating lease.

--In early years net income and cash flow from financing are lower in finance lease in comparison to operating lease.

--Though total cash flow and total income remain same in both the leases