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Hello Sir, can you please explain to me how treating a lease wrongly as an operating lease adversely affects operating margins and liquidity ratios?
I would like to understand what component exactly leads to deteriorating liquidity ratios and operating margins here?
Please clarify that you are considering the books of the lessor, as lessees no longer use the FL/OL classification. Is this an old question?
This is related to question no.23 Star, from bpp kit. This is definitely from lessee’s perspective?
AS per the ques, directors are entering into a 5 year leasing arrangement and they’ve got a debt covenant so they’re purposely wanting to classify the lease as short term lease so they can expense out the lease rental in P&L as compared to when the ROU is recognized where the depreciation expense would be lower than short term lease classified rental.
Is this ques outdated?
OK – you can say short term but you cannot say operating.
If the directors classify as short term (less than 12 months):
1. The whole rental expense will be charged as operating cost. If the lease had been capitalised, only the depreciation would be an operating expense.
2. There will be no short term lease liability – in fact, no lease liability at all.
So, if wrongly classified, I think:
1. OP margin will be lower
2. Current ratio will be higher.(I think!)
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