capital lease

[tammylatalpa1976]

Effects on ratios.
I don't understand why net income using capital lease should have a lower net income than operating lease and a higher EBIT.
Can u help me pls ?

 

[wingman]

because in a capital lease, there is the depreciation and the interest components that affect the P&L whilst in the operating lease, there is only the lease payment hitting your P&L. In the early years, your interest expense calculated on the value of the lease is higher (value of the lease is a function of the discounted value of MLP) and declining over the term of the lease. Depreciation on the other hand assuming SL is constant through the life of the lease. Therefore in earlier years, you would expect a higher total P&L effect using the capital lease method, hence the lower net income.

EBIT takes into account for a capital lease the depreciation portion which and excludes the interest component. therefore, compared to the lease payment, depreciation expense is much smaller and thereby making EBIT on a capital lease higher

 

[Krish]

In an operating lease, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. In a capital lease, lessee gets to claim depreciation each year on the asset and also deducts the interest expense component of the lease payment each year.
In general, capital leases recognize expenses sooner than equivalent operating leases.

So net income using capital lease have a lower net income than operating lease.
However EBIT is higher under capital lease, because interest expenses under capital lease are not deducted from EBIT.

 

[jamespucyk]

Exactly; interest component is a huge component.

I remember it like this.

Operating lease Payment = Operating Expense; it effects EBIT

A Capital lease Payment Component = Interest; Does not effect EBIT wholy



Edited 1 time(s). Last edit at Tuesday, April 4, 2006 at 10:09AM by jamespucyk.