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How can classification of a lease as a finance lease me used as a strategy to understate liablilties and show a better position in financial statements
Because it keeps a lot of expense off the statement of profit or loss (100% x operating lease rental compared with finance lease interest + depreciation) but, significantly, it keeps the cost of the asset off the statement of financial position so “capital employed” is kept artificially low
It also keeps the finance lease payable obligations away from the liabilities – both current and long term
No but sir the finance lease obligation would be there in balance sheet, and you said naturally and interest + depreciation expense is there in SOPL , and capital employed understated , why would a company want to treat the lease as a finance lease in this case, I understand why they would want to switch to an operating lease from a finance lease but not vice versa
Ok, it rather depends on what the entity is trying to show by these manipulations!
If we are trying to keep major expense off the Statement of Profit or Loss, then capitalise and hope that depreciation + finance lease interest is lower than operating lease payments
If the entity wants to show increased value in assets, then capitalise as a finance lease
If they don’t want to show lots of assets, then treat as operating lease
Your question asks: “How can classification of a lease as a finance lease me (be) used as a strategy to understate liablilties and show a better position in financial statements”
That, I don’t know. How will classification as a finance lease understate liabilities? No idea!
Have you written the question correctly?
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