capital lease from lessor's view and current ratio

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korn

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Hi all,
Please could you tell me why current ratio decrease when you use capital lease rather than operting lease from the view’s point of lessor?
Thanks
korn
 
Hmm. I’m having a hard time figuring this one out.
It would remove the asset from it’s balance sheet, but that wasn’t a current asset in the first place, and instead replaces it with a lease receiveable, which I’d assume to be a current asset. So, I’d actually expect the CR to increase.
Where are you seeing this?
 
Would a multi year lease receivable not be classified as a “non current asset”?
So when the lease is capitalised, from the leasor’s perspective the asset gets removed from “inventory” which is a current asset, and they take on a “lease receivable” which is a non current asset - or at least part of it is “non current”.
Therefore current assets decrease, as does the current ratio.
Bear in mind I have absolutely no FRA exerience other than level 1/2 CFA so I could very well be wrong. But that would be my guess.
 
I would suspect if you’re leasing an asset then it would not be removed from inventory, but instead from PP&E
 
If a car dealership or a company that produces heavy construction machinery enters into a financing lease from the perpective of being the leasor, then they would classify the car/heavy truck that they “sell” as inventory, and the leasee would classify it as PP&E once they have transfered the asset to their balance sheet.
Caterpillar for example, classifies their contruction equipment available for sale/leasing as inventory until they lease it - as that is their whole business.
 
It still seems like such an open-ended question to say then that the lessor’s current ratio will decrease because I’m sure I can think of instances where the asset that they’re leasing come from PP&E. At least, I’d assume that could potentially be something that happens
 
I agree with S666.
I think this applies to cases where the lessor is manufacturing inventory (current assets) to be leased/sold. By executing a capital lease, the inventory is removed from the B/S, and a non-current lease receivable is created (since it should be outstanding beyond one operating cycle or year). Current assets decline, which causes the Current Ratio to decline.
 
Usually financial leases come from fixed assets straight out of PP&E… Hence i’d see the current ratio increase, since CL is untouched, and CA would increase, since the current portion of the financial lease receivable will be moved to CA…
 
Gurifissu wrote:
Usually financial leases come from fixed assets straight out of PP&E…
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May I ask what leads you to believe this?
I always think of a car dealership when I am approaching these questions regarding finance/operating leases as it is the example used in the curriculum to examine operating leases, financing leases and sales type leases from the perspective of both the leasor and the leasee (I.e. Pretty much all forms of leases from all perspectives)
A car dealership holds its stock of cars as inventory, but when leasing to a mini cab firm for example, the minI cab firm would classify it as PP&E.
That framing seems to set me in decent stead when answering the questions in the curriculum…
 
Gurifissu wrote:
Usually financial leases come from fixed assets straight out of PP&E… Hence i’d see the current ratio increase, since CL is untouched, and CA would increase, since the current portion of the financial lease receivable will be moved to CA…
Click to expand...
For the lessee, sure, it’s part of PP&E. From the perspective of the lessor, it was inventory (not something they were planning to use in their own operations, such as their own PP&E, which is not being leased to someone else).
Also, the portion of the NC lease receivable that becomes a CA is still less than the value of the inventory that was removed from the B/S– a net decrease in CA.
 
So are we saying then that a lessor can never lease anything out of PP&E? Or simply that it’s uncommon?
Assume I’m a railroad company dealing with shipping and distribution. I do not sell my trains, but I use them for transit. If for whatever reason I decided that I wanted to lease out one of my trains to another company, this to me would come directly out of PP&E and not Inventory.
I am not sure we can make a blanket statement and say that all leases from a lessors prespective will reduce inventory – can we?
 
Mosstastic wrote:
So are we saying then that a lessor can never lease anything out of PP&E? Or simply that it’s uncommon? I think never straight from PP&E, but it could be classified from PP&E to another NCA before the leasing(which I think isn’t very common for the purpose of looking at leases).
Assume I’m a railroad company dealing with shipping and distribution. I do not sell my trains, but I use them for transit. If for whatever reason I decided that I wanted to lease out one of my trains to another company, this to me would come directly out of PP&E and not Inventory. I’m not entirely sure, but I’m pretty certian you would need to reclassify that train from PP&E to some sort of held for sale/disposal account (a non current asset, if I recall)– making it no longer PP&E. So, it’s possible, I think, that it would have no effect on CA, as you said, but (in all likelihood) it would not come straight from PP&E. This was covered a little bit in LI.
I am not sure we can make a blanket statement and say that all leases from a lessors prespective will reduce inventory – can we? Again, I don’t think it would always be inventory, depending on how it was originally classified. However, I’m pretty positive it would not be from the lessor’s PP&E (but it might not effect CA, since it could go as a NCA PP&E to NCA held for sale). For the purposes of this topic, though, I think the Institute is testing you on normal situations– the manufacturer leasing out its inventory, for example.
Click to expand...
 
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