FSA: finance lease finance, highter, assets, reduce, later

soverby

if an operating lease is treated as finance lease,
as deprecation reduce the assets, in laters, will the interest+depreciation gradually smaller than operating lease expense? . so NI is highter in finance lease in later year than an operating lease? Thanks.

Swanand

Correct!

Thing to remember is that in both cases the amount of lease payments are the same! However when you capitalize a lease, the PV of the lease payments creates both an asset & liability. The asset is reduced each year by depreciation. The liability is reduced by the lease payment.

Remember, under an operating lease, the lease expense = lease payment, ie rent. Under capital lease, the associated lease expense is depreciation & interest expense. Therefore while your actual cash outflow of lease payments are the same in both operating & capitalizing, your expenses are different (think accruals) on the income statement.

So the capital lease expense is higher in earlier years but comes down in later years because although depreciation remains constant, interest comes down as the liability is amortized by the amount of rent expense (think typical debt amortization schedule, and lease payment = reduction in principal). This means lower Net Income in earlier years, higher in later years. Total Net Income is the same!

onelife1

also remember that if you were to capitalize a lease that was originally operating, you need to adjust the CFs as well. Since under operating you had just rent expense that depressed NI, you need to add back the Depreciation portion to CFO and then the interest part is subtracted from CFF since it would be as if you paid off part of an amortized loan.

brainsX

partly aggree. The portion of the payment as interest reduce CFO, portion towards principle reduce CFF....



piwanowi Wrote:
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> also remember that if you were to capitalize a
> lease that was originally operating, you need to
> adjust the CFs as well. Since under operating you
> had just rent expense that depressed NI, you need
> to add back the Depreciation portion to CFO and
> then the interest part is subtracted from CFF
> since it would be as if you paid off part of an
> amortized loan.