Dunno how important leases will be on the exam, but does anyone actually get it all??? All I can retain is that finance leasing increasing B/S and Operating Leases don’t… BLAH!!
What’s your specific question? Finance lease increases your assets by the same amount your liabilities increase. You do a finance lease on a doughnut machine; the doughnut machine is an asset on your B/S, the present value of the future lease payments is a liability on your B/S. They offset each other. Operating leases don’t show up on your financial statements at all except for a yearly expense amount on the rent/lease/etc payment.
Well you have two types of leases an Operating Lease which records rent charges on the income statement and passes through CFO and does not get capitalize on the balance sheet and a Finance lease which you capitalize the PV of the future lease payments and depreciate over time and you record interest expense & depreciation in your CFO and you report principal payments in your CFF just like if you were purchasing the leased item. Now, US GAAP requires that you use a finance lease when the following 4 criteria are met. 1) Lease term is >=75% of the economic life of the item 2) PV of minimum lease payments are >=90% of FV 3) You transfer the ownership of item at the end of the lease 4) There is a bargain purchase option at the end of the lease. When recording Finance leases remember that your take the PV of the lease payments and capitalize as an asset and liability on BS. For Cash Flow - multiply the interest rate by the PV and that is recorded as your interest in CFO. Then subtract the interest from the payment and that records your principal in CFF. Each period you will depreciate the item based on its expected life and record as book value. Each subsequent period you will deduct the principal and multiply the interest by the remaining value until the end of the lease. Oh and remember from level 1, sometimes they trick you with beginning period or ending period lease payments remember to switch your calculator accordingly. Sorry for detail but I just did this in level 1 in Dec. and I had a note card handy.
I get it…but I spent 15 years structuring operating and capital leases and evaluating them both from the lessor side and the lessee side…so I kinda have an advantage there. But even so, I still run across questions that make me think. Better learn it now though because FASB is talking about changing it all in the next year or so…
It’s all going to be useless knowledge next year anyway, right? They’re all going to be taken onto the B/S, aren’t they?