If a company leases OPERATING LEASES, in contrary with CAPITAL LEASES, niether asset nor liability will be recorded in the balance sheet related to the lease? Thanks!
Correct. It is recognized as a periodic expense on the income statement. Once capitalized, it is treated as an asset, depreciated, and a liability for the lease payment is placed on the balance sheet. The income statement no longer has the lease payment as an expense, but rather has the depreciation expense.
In the case of an operating Lease --> The lease expense is equivalent to a Rental Expense. For a Capitalized Lease – as wyantjs has pointed out above --> An Asset and a Liability are created. The liability comprises two portions: 1. A current liability – which is the PV (MLP) [Present value of minimum lease payments] due in the current accounting period. 2. A Long Term liability – remaining portion of the PV(MLP) due. and for those who are trying to determine some way of remembering when a Lessee should capitalize: remember the following acronym: SNOB A lessee would capitalize when he is a SNOB: (any 1 of the following conditions) S: Lease term >= 75% of Life of the asset (S from 75) N: PV (MLP) >= 90% of Cost of the Asset (N from 90) O: Ownership transfer at end of the lease. B: Bargain purchase option at the end of the lease. A Lessor would capitalize when : 1. The lessee capitalizes and any of the following conditions 2. There are no guarentees that the MLP would be made. or 3. Lessor is responsible for additional expenses. The PV (MLP) would be calculated at the LOWER of 1. Lessee’s opportunity cost of capital and 2. The Rate implicit in the lease. Reason for using the LOWER Rate --> to ensure the PV(MLP) becomes more than 90% and therefore there is a higher possibility of the Lease getting capitalized, and hence coming ON THE BOOKS. CP
^ I love this guy. The acronym still sucks though.
Guys thanks a lot for the clear explanation. I have another two “stupid” question in the same area, Off-Balance-Lease: When a company Silvio lease a machine (it is considered as capital lease because xxxxx ), the lease is for company B for four years with annual payments of 10 K. The cost is 30 K to produce the machine. In four years Silvio will be able to sell the machine for 6K. The implicit discount rate is 6 percent. In the Balance Sheet, the Capital lease PV is reported as Net Investment In Lease i/o A Liability ----) Net Investment is reported under Assets??? In Silvio (the LEASOR) lease Amortization Schedule as below: Year Payment Interest Reduction in net investment Net investment in lease 0 39.404 1 10.000 2.364 7.636 31.768 2 10.000 1.906 8.094 23.674 3 4 Why the Net investment in lease = Net Investment Y-1 - Annual Payment 10.000 + Interest ??? It is the sams as in a LEASE’s Capital lease calculation.
zjqadele, If this is a Capital Lease as you have stated – it is NOT a OFF Balance sheet Lease. It is on the Balance sheet. When the Lease is on the Balance sheet - an Asset and a Liability are created on the Balance sheet. The total Lease Payment (very similar to your mortgage payment) comprises of two portions: Interest expense and Principal reduction. Interest Expense = Net Liability Y-1 * Interest Rate. Principal Reduction = 10000 - Interest Expense (10000 = Lease Payment). So Net Liability Y = Net Liability for (Y - 1) - Principal Reduction = Net Liability for (Y-1) - (10000 - Interest Expense) = Net Liability for (Y-1) - 10000 + Interest Expense Hope this answers your question. CP