When capitalizing a lease, we split the lease payment into interest expense and principal to account for the in the Cash Flow Statement.
We report the interest expense under Cash Flow from Operations (CFO) and the principal under Cash Flow from Financing (CFF). Can someone provide an intuition for this? IFRS allows ‘Interest Paid’ to be classified as operating or financing CF while US GAAP requires classification as operating CF but I could not find a anything about how principal has to be classified (‘interest paid’ is not the same as ‘interest expense’ I guess).
The Schweser notes say that CFF includes everything that reduces a company’s debt, does this imply we have to include the principal here, because it is a repayment of debt that actually reduces debt, while the interest expense does NOT reduce debt.
Also, since IFRS allows the classification of ‘Interest Paid’ as operating OR financing, does this imply that we could put both, the interest expense and the principal into CFF?
Correct Greenman. (Well, almost correct: interest _ paid _, not interest expense (which may be accrued).)
It’s particularly annoying that under US GAAP, interest expense is a nonoperating expense (on the income statement), but interest paid is an operating cash flow. Another stupid inconsistency that candidates have to memorize.