Question

1. Which company has the greater return on equity based on the following information:

Company	1	2 – Capital
Revenue	35,000	39,000
Other expenses	12,000	12,500
Interest	922	838
Lease categorization	Operating	>75 of useful life
Lease payment	5,750	5,223
Life of lease	4	5
Current year of lease	2	3
Total equity	500,000	620,000
Incremental borrowing rate	6%	6%

Answer 1

Company B is profitable in the current year :

Particulars	Company 1	Company 2
Revenue	35,000	39,000
Other Expenses	(12,000)	(12,500)
Interest	(1,195)	(1,086)
ROU Depreciation	(4,981)	(4,400)
	16,823	21,014
Capital	500,000	620,000
Rate of Return	3.36%	3.39%

Working Notes :

For company B it is mentioned that lease categorization is <75% of useful life. As per IFRS and US GAAP where lease asset is having lease period less than 75% of useful life is not a finance lease so it will also be categorized as operating lease.

Under operating lease lessee accounts for :

Deprecation on Right to Use(ROU) Asset and also accounts for interest expense.

The ROU = Net present value of lease payment

Company A = NPV(6%,5750,5750, 5750,5750,) = 19,924, ROU Depreciation 4981 = 19,924/4

Company B = NPV(6%,5223,5223,5223,5223,5223) = 22,001, ROU Depreciation 4,400 = 22,001/5

Company A calculation of Implied Interest :

Opening Balance	Interest	Lease Payment	Principal repayment	Closing balance of principal
$19,924	$1,195	$5,750	$4,555	$15,370
$15,370	$922	$5,750	$4,828	$10,542
$10,542	$633	$5,750	$5,117	$5,425
$5,425	$325	$5,750	$5,425	$0

Company B calculation of Implied Interest :

Opening Balance	Interest	Lease Payment	Principal repayment	Closing balance of principal
$22,001	$1,320	$5,223	$3,903	$18,098
$18,098	$1,086	$5,223	$4,137	$13,961
$13,961	$838	$5,223	$4,385	$9,576
$9,576	$575	$5,223	$4,648	$4,927
$4,927	$296	$5,223	$4,927	($0)