How come in some problems the lease expense is comprised of the interest expense on the PV of liability PLUS the depreciation expense, BUT in some problems, it is comprised of interest expense and principal payment? For example, in some problems, you are told that operating lease payment is 10,000 and you find that interest expense for purposes of capital lease is 4,000 so you know that capital lease expense is 10,000 with 4,000 coming from CFO and 6,000 principal payment coming from CFF. But in some problems, you just add the interest expense to the depreciation expense. Am I missing something?
You’re likely to get better feedback by posting an example (or two).
I think you are confusing expenses on the income statement and cash flows from the cash flow statement. For expenses the capital lease has an interest expense and depreciation expense. For cash flows, depreciation is not a cash flow. Rather you are dealing with interest expense in CFO and principal repayment in CFF.
I think you are confusing (so was I) between Capital leases and Capitalizing Interests. Capital leases would be capitalized so the interest+depreciation would add up to more than just lease expense in the Early years. Here we are pretending as if we borrowed the amount to FINANCE an asset. So A+ and L+; operationally, Interest expense from Debt and Depreciation expense from Asset are incurred. As analysts, we PREFER that this liability is shown. Split the expense between Int-CFO and principal-CFF, so CFO is up and CFF is down relatively. Now, Capitalizing few R&D and other interest costs so the management can hide and show better coverage ratios(EBIT/INT). Here mgmt pretends that it took some equity and INVESTED in the asset such as Software. Here, as analysts we need to UNDO this effect, so we add back the INT and DEPR to the EBT and divide the resultant EBIT/(reg int+ cap int) to get a lower coverage ratio. Undo the effect it had had on CFI. So CFI is higher now.
I think my confusion is more along the lines of what littlefinger alluded to. In some places I am reading that lease expense is made up of the interest plus depreciation, but in some places it says interest plus the difference between total lease payment and interest (the cff portion). For example, compare these two statements: Schweser Secret Sauce page 113: The lease payment is separated into interest expense and principal payment on the lease liability (the lease payment less the interest expense). Schweser Exam 2PM answer: The reported annual lease expense for a capital lease is the depreciation of the asset value plus the annual interest on the remaining lease liability. Do you guys see what I mean? Do lease PAYMENT and lease EXPENSE mean two diff things?
Yes… Lease payment is the actual payment contracted with lessor. Lease expense is the expense you booked per f/s. Now, the show NY Wrote: ------------------------------------------------------- > I think my confusion is more along the lines of > what littlefinger alluded to. > > In some places I am reading that lease expense is > made up of the interest plus depreciation, but in > some places it says interest plus the difference > between total lease payment and interest (the cff > portion). ===> This probably is due to booking expense using a) the lower of between irr using PV and b) irr using fair market value. When the latter is used, you may have to use the difference between lease payment and interest expense booked as cff or for principal repayment, so to speak > > For example, compare these two statements: > > Schweser Secret Sauce page 113: The lease payment > is separated into interest expense and principal > payment on the lease liability (the lease payment > less the interest expense). > ==> if b) is used > > Schweser Exam 2PM answer: The reported annual > lease expense for a capital lease is the > depreciation of the asset value plus the annual > interest on the remaining lease liability. > ===> if a) is used > Do you guys see what I mean? Do lease PAYMENT and > lease EXPENSE mean two diff things? Does this help?
Not sure where the IRR is coming from but I think my question is answered. When the question asks for lease payment, you are being asked what you are PAYing out to the lessor. This should be the amount of the annual lease expense, and the same as what you would pay under operating lease. So if operating lease payment was 10,000 from CFO, your lease payment would be 10,000 split between CF0 and CFF. Now if they asked for your lease expense (for example, a question where they give you net income and depreciation information and ask you to find the income–or something like this, haha), then you would add up the interest cost with the year’s depreciation expense to find the lease expense. The lease payment will ALWAYS be the same (i.e. constant 10,000 each year split between CFF and CFO), while the lease expense will vary because the interest expense will vary (lease payment starts off high because interest is high in early years, and then gets lower due to decreasing PV of Min Lease Payments). This is my understanding now. Any mistakes?