Finance VS Operating Lease

[CFA_silverbullet]

Hi,

In regard to accounting and reporting for Finance and Operating lease

1. as a lessor, why add back the investing cash flow in the Statement of Cash Flow for Finance lease?

2. as a lessor, why minus the Interest Receivable for the 1st year and add back the differences thereafter?

i am referring to example 13 under Reading 16 in the CFA text book. i am not very clear on the accounting and reporting rules, are there a better way to approach this topic?

Thanks.

[S2000magician]

1. I’m not sure that I understand the question. Are you asking merely why they include CFI in the statement of cash flows (that’s easy: you always include CFI in the statement of cash flows), or how they got the numbers they’re using (those are the principal payments on the lease)?

2. This is CFO via the indirect method: you start with net income and, amongst other things, subtract any increase in A/R or add any decrease in accounts receivable. Because the payment is at the beginning of the year, the interest accumulates for the previous year, unpaid, then is paid at the beginning of the next year.

[CFA_silverbullet]

@S2000magician

1. I’m not sure that I understand the question. Are you asking merely why they include CFI in the statement of cash flows (that’s easy: you always include CFI in the statement of cash flows), or how they got the numbers they’re using (those are the principal payments on the lease)?

sorry if i wasn’t clear before. from the lessor perspective, Payment Received on Finance Lease, which is equal to Investing CF, is being added back to get the Change in Cash. i thought the only revenue that the lessor get is the interest payments.

2. This is CFO via the indirect method: you start with net income and, amongst other things, subtract any increase in A/R or add any decrease in accounts receivable. Because the payment is at the beginning of the year, the interest accumulates for the previous year, unpaid, then is paid at the beginning of the next year.

i guess i don’t understand how Finance Lease works. my understanding of Finance Lease is that the lessor finance the asset and the lessee pays the interests to the lessor. at the end of the period, lessee has the option to buy the asset. the lessor don’t record this asset on its balance sheet. is this correct?

thanks.

[S2000magician]

The payments on a finance lease are part interest and part principal.

I wrote a series of articles on leases that may help clear up some of your difficulties: http://financialexamhelp123.com/leases-general/.