Capitalizing the Value of Operating Leases
The following information comes from the financial statements of Travis Campbell Company.
Total stockholders’ equity
Property, plant, and equipment
In addition, Travis Campbell has a large number of operating leases. The payments on these operating leases total $30,000 per year for the next 10 years. All of these lease payments occur at the end of the year. The incremental borrowing rate of Travis Campbell Company is 10%. This is also the rate implicit in all of the leases that Travis Campbell signs.
1. Compute the following ratio values:
(a) Debt ratio (total liabilities/total assets).
(b) Debt ratio, assuming that Travis Campbell’s operating leases are accounted for as capital leases.
(c) Asset turnover (sales/total assets).
(d) Asset turnover, assuming that Travis Campbell’s operating leases are accounted for as capital leases.
2. Briefly describe how the accounting for assets used under operating leases distorts the values of financial ratios.