Question

Airline C accounts for the acquisition of its planes as capital leases whereby an asset and related debt are recorded on the balance sheet. The monthly lease payments are mostly expensed as interest, with a smaller portion recorded as a reduction in debt. Airline O treats its plane leases as operating leases whereby lease payments are treated as an operating expense and no assets or liabilities are recorded. Briefly explain which financial ratios will be affected by

Answer 1

The acquisition methods for plane leases by Airline C and Airline O affect the debt-to-equity ratio, return on assets, and asset turnover ratio, with Airline C showing a higher asset base and liabilities due to capital leases.

Step-by-step explanation:

The financial ratios affected by the way Airline C and Airline O account for their plane leases include the debt-to-equity ratio, return on assets (ROA), and asset turnover ratio. Airline C, which treats its planes as capital leases, will show higher assets and liabilities, leading to a potentially higher debt-to-equity ratio compared to Airline O, which treats its plane leases as operating leases and doesn't record the planes as assets nor the leases as liabilities. Similarly, Airline C's ROA may be lower because the total assets are higher, which could dilute the return on assets calculation. Lastly, the asset turnover ratio might be lower for Airline C due to the increased asset base without a proportionate increase in revenue.