CFA Practice Question

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CFA Practice Question

Which of the following statements concerning the effect on the lessee immediately after erroneously recording a leased asset as an operating lease rather than a capital lease is true?

A. The return on equity (ROE) ratio is overstated.
B. The return on equity (ROE) ratio is understated.
C. The debt-to-equity ratio is understated.
Correct Answer: C

By recording the transaction as an operating lease, the lessee does not record the long-term debt associated with the lease. This makes the numerator smaller, resulting in a lower debt-to-equity ratio.

User Contributed Comments 9

User Comment
kuan Does not affect Equity but Asset
danlan Does not affect income neither, so ROE is not changed.
danlan Previous comment may be wrong, it affects income. I think it makes income lower in early stage (because of interest expense), so ROE is understated?
Done C is correct because no entry is made at the inception of the lease. The leasehold asset and leasehold liability equal the PV of the lease payments. I think?
mtcfa I thnk the important factor in this question is the word immediately... the actual lease payment would not be recorded until it actually took place, thereby not immediately affecting net income. The balance sheet items, however, would be affected immediately.
malawyer I support mtcfa - it depends on the timing, just like dividends being declared or paid...
antihead It does affect income and hence the return on equity. however, the question asks what is happening immediately this point the annual depreciation is yet to be made.
quanttrader capital lease - take on debt, op lease - take on no debt
gill15 That is tricky --- to realize that we havent taken depreciation expense into account...good pickup antihead... name ever....i needed that cfa break..
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