Star Corp. has a rate of return on assets of 10% and a debt/equity ratio of 2 to 1 before entering into an operating lease. Not including any indirect effects on earnings, when Star Corp. records the operating lease, the immediate impact on these ratios is a(an):
A) Option A
B) Option B
C) Option C
D) Option D

Question

Star Corp. has a rate of return on assets of 10% and a debt/equity ratio of 2 to 1 before entering into an operating lease. Not including any indirect effects on earnings, when Star Corp. records the operating lease, the immediate impact on these ratios is a(an): 
A) Option A 
B) Option B 
C) Option C 
D) Option D

Quizplus · Accepted Answer

An operating lease increases assets (ROU asset) and liabilities (lease liability) the same amount and thus has no effect on equity, which is A minus L = Equity. Because assets, the denominator, increase and earnings remain the same, the rate of return decreases. In the debt/equity ratio, the numerator is increased with no effect on the denominator and the ratio increases.

Star Corp Has a Rate of Return on Assets of 10