Capital lease, depreciation and CFO

CFA Level I FRA
#1

Hi! Very curious about:

Capital lease. We depreciate equipment (=principal repayment to lessor) on the BS.
In Cash flow from operaton we have: NI + Depreciation (=principal repayment to lessor) +…
In Cahs flow from financing we have: … - Lease payment (=again principal repayment to lessor)
So NET CASH is unnaffected: +Depreciation - Lease payment.

I see inly one way to explain this situation: we do not “depreciate” capital lease. It is just “lease payment” wich is in CFF. However, companies repport depreciation if equipment on the BS (capital lease).

Also, in P&L we have 2 costs: depreciation (COGS=principal lease payment) and lease payment. So we double it as well?

I spent to much time to find out…

#2

Let’s see an example based on IFRS 16:

Lease payment = $50000 (payable annually)
Lease tenor = 8 years
Lease rate = 6% per annum

Depreciation of leased asset using straight-line method for 8 years (Zero salvage value).

I’m using Texas BA II, so:

PMT = 50000
I/Y = 6
N = 8
FV = 0
CPT PV = -310,489.69

Depreciation ~expense = \frac{310,489.69}{8} = 38,811.21

For Year 1:

Depreciation expense = $38,811.21

Interest ~expense = Beginning ~Lease ~Liability \times Lease ~Rate
Interest ~expense = 310,489.69 \times 6\% = 18,629.38

Principal repayment = Lease payment - Interest expense
Principal repayment = 50,000 - 18,629.38 = 31,370.62

Impact on Income Statement:

EBIT = Gross profit - SG&A - 38,811.21 Depreciation

EBT = EBIT - 18,629.38 Interest expense

Impact on Balance Sheet

Cash: Decreases by $50,000 lease payment
Right-of-Use asset: Decreases by $18,629.38 depreciation expense

Lease liability: Decreases by $31,370.62 principal repayment

Impact on Cash Flow Statement

For the lease payment of $50,000:

  • principal repayment = $31,370.62 (CF from Financing activity)
  • interest on lease = $18,629.38 (CF from Financing/Operating activity)

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Hope it helps

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