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Finance Lease And the Balance Sheet

Hi guys,

Can anyone explain how a finace lease would be recorded on the balance sheet to get A-L=E to hold.

Assume in year 1: 10,000 lease payment, interest exp of 2,079, depreciation of 8,663, and a lease liability and asset of 34,651.

I believe that acc. depr goes up by 8,663 (assets down), interest payable goes down by 2,079, (liabilities down), and retained earnings are down by the sum of the two, flowing through the income statement. That balances. But then what is happening to the lease liability and asset you create, are they just sitting there?

Any help appreciated!

Thanks!



Edited 1 time(s). Last edit at Saturday, March 12, 2011 at 01:08PM by ftwcfa.

WHy does the intereste payable go down by 2079? Shouldn't it go up?

I think the lease liability amortizes while the asset depreciates...

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i think Palantir is right, you amortize the liability (meaning decrease it gradually over time according to what rate?) and depreciate the capital asset

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just know this stuff and you'll be fine (copy paste from word so the formatting's not great):


EBITcapital lease = EBIToperating lease + Lease payment - (PV of lease pmts/# years of lease)
Interest expense w/ capital lease = Interest expense w/ operating lease + (r ?? PV of lease PMTs)

Assetscapital lease = Assetsoperating lease + PV of lease payments*
*Debt would also increase by this amount

- PV of lease PMTs is an asset because it?|s considered that you own the building/whatever being leased. Since you own it, you depreciate it.
- A certain portion of the lease payment will be interest, and the rest, principal. The interest portion reduces net income for the period, but the principal portion does not.
o Ex. Lease PMT $200, r = 5%, lease term = 10 years, PV = 1544.35
o In the first year of the lease, you would have:
?X Lease payment of $200
?X Interest expense of $77.22 (operating CF)
?X Principal Payment of $122.78 (investing CF)
?X End of year lease PV of 1421.57 (1544.35 ?V 122.78)
?X Depreciation expense of whatever; (management would choose depreciation method)
- Although assets are affected in the manner described above, Equity would not be (the counterbalance is Liabilities, not equity)



Edited 1 time(s). Last edit at Wednesday, March 16, 2011 at 12:49PM by magicskyfairy.

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thanks magic- correct, the TOTAL payment is $200, so it's just 5%*(1544.35)= 77.22 goes to interest expense and the rest (122.78) is principal payment.

How many people think this will be on the test given that it was level 1 in December? Is it still on level 1 or was this actually moved?

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Two corrections on magicskyfairy's notes:

1)Principal payments are recorded as a financing cash outflow not an investing (since we are talking about lessee).

2)In the first year of the lease the full amount of lease payment is recorded as financing CF
(i.e. $ 200) and is not broken down to interest expense ($ 77.22) and principal payment ($122.78).

The breaking down occurs in the second year.

I do not know the reason but that's what CFAI text (p.94, example 11) says.

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Yeah, i don't think so, but will check when I get home

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recall what an investing cash flow is:

What Does Cash Flow From Investing Activities Mean?
An item on the cash flow statement that reports the aggregate change in a company's cash position resulting from any gains (or losses) from investments in the financial markets and operating subsidiaries, and <B> changes resulting from amounts spent on investments in capital assets such as plant and equipment <B>.

the principal amount spent is a cash flow towards owning the PP & E item in question, and these notes I made were based on CFA EOC solutions, so I still think it's and investing CF, but definitely will verify when I get home to be sure.

as for the second point, I've never heard of that in my life or seen any mention of that in the CFA readings, but maybe someone else on this forum can vouch for you? i doubt it though, that sounds very strange



Edited 2 time(s). Last edit at Thursday, March 17, 2011 at 10:08AM by magicskyfairy.

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a lot of sites on internet are calling it a financing CF, but I wouldn't have called it an investing CF unless there was something in the CFA text that convinced me that's what it was, so I'm starting to lean more on your side about the financing cash flow, but still gonna check it out in official text. thanks for pointing that out

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I figured out your second point;
if you're making end of year payments, then my method of separating the interest and principal is correct;

if you're making beginning of year payments, there will be 0 interest accrued at the inception of the lease, so in that case, the whole first payment would go to principal.

the only oncertainty now is whether principal payment is investing or financing, and I'm leaning more towards financing now, but will check that out later.

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