What is the effect of classifying a lease as an operating lease, as opposed to as a finance lease, on the debt to equity ratio and the times-interest-earned ratio?
$\begin{array} { l l l }
& \text { Debt to equity ratio } & \text { Times-interest-earned ratio } \\end{array}$
a) $\begin{array} { l l l } && \text { Overstated } &&&&&& \text { Overstated } \\end{array}$
b) $\begin{array} { l l l } && \text { Overstated } &&&&&& \text { Understated } \\end{array}$
c) $\begin{array} { l l l } && \text { Understated } &&&&& \text { Overstated } \\end{array}$
d)$\begin{array} { l l l } && \text { Understated } &&&&& \text { Understated } \\end{array}$

A) Choice A
B) Choice B
C) Choice C
D) Choice D

Question

What is the effect of classifying a lease as an operating lease, as opposed to as a finance lease, on the debt to equity ratio and the times-interest-earned ratio?
 $\begin{array} { l l l } 
 & \text { Debt to equity ratio } & \text { Times-interest-earned ratio } \\end{array}$
a) $\begin{array} { l l l } && \text { Overstated } &&&&&& \text { Overstated } \\end{array}$
b) $\begin{array} { l l l } && \text { Overstated } &&&&&& \text { Understated } \\end{array}$
c) $\begin{array} { l l l } && \text { Understated } &&&&& \text { Overstated } \\end{array}$
d)$\begin{array} { l l l }  && \text { Understated } &&&&& \text { Understated } \\end{array}$

A) Choice A
B) Choice B
C) Choice C
D) Choice D

Quizplus · Accepted Answer

Classifying a lease as an operating lease, rather than a finance lease, results in lower reported liabilities on the balance sheet, which understates the debt to equity ratio. Operating leases do not add interest expense (since lease payments are considered operating expenses), potentially overstating the times-interest-earned ratio by not including the interest component of lease payments.

What Is the Effect of Classifying a Lease as an Operating