CFA Practice Question

CFA Practice Question

If a lease is capitalized, as compared to being treated as an operating lease, the first-year impact would be

I. a higher EBIT.
II. a lower interest expense.
III. a higher total expense.
IV. a higher operating expense.
A. I and II.
B. III and IV.
C. I and III.
Explanation: Capitalization results in a higher EBIT as the straight-line depreciation expense is usually lower than the OL rental expense. The total expense includes interest expense as well.

User Contributed Comments 10

User Comment
shasha what's wrong with II? operating lease takes full amount of lease payment as interest expense, whereas capitalization takes only part of it as interest expense, the balance debits to lease liability.
blumonster operating lease are charged off as rental expense.
anricus I thought the expense was the same but as follows

Lease expense under operating lease = interest expense + depreciation
danlan It's talking about lease capitalization and not capitalization of expense.
danlan II is not correct, since for operating lease, interest expense is 0!
volkovv I is definitely correct, depreciation under capital lease is lower then rental expense under operating lease, hence EBIT is higher.
CFAMarco what about III, i thught it was the same expence one as interest and principal and the other as rent, why is it greater?
Adkins Under capital lease, the expense is depreciation (part of EBIT - operating expense) and interest.
1 is correct as EBIT is higher (depreciation in every known case is less than rent expense)
2 is incorrect as interest expense must be higher (no negative interest rates)
3 is questionable as it depends on the lease terms, interest rate and PV
4 is the opposite of 1, so that is incorrect.
1 and 3 being correct is the only logical answer.
manju79 If lease payment is same for cap and op leases. Then

Lease Payment= Rent Exp (Op)= Int Paid+Depreciation
xemex131 weird answer, higher EBIT and higher total expenses don't go together..
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