LESSOR accounting

CFA Level II
#1

Can I clarify why the lessor who recognises an operating lease instead of a direct finance lease has the following:

  1. Lower NI

  2. Higher CFO

  3. Lower CFI

Is lower NI because you are not receiving the interest payment as well?

Why is CFO higher? As the lessor when you receive interest payments as well as principle this all contributes as a CFO inflow no? Therefore if we move to operating lease does CFO not reduce?

  1. why lower CFI?
#2

A lessor that recognises an operating lease will recieve a fixed payment and will continue to depreciate the asset.since he is not receiving any part payment as principal and interest CFI will be lower as compared to financing were principal payment is recorded in CFI. A higher CFO bcoz the fixed payment is recorded in p&l whereas under financing some in CFI and some in operating(fixed payment is higher as compared to interest income).Lower net income in operating lease because of depreciation and also interest income in financing is higher in early years therefore interest income is more than fixed payment-depreciation in early years in financing lease hence higher NI in early years.

#3

  1. Operating lease will have a lower NI but only for the earlier years, total NI still the same in the end. Because the operating lease has to recognize depreciation (he still owns the asset), whereas the finance lease does not recognize depreciation (he no longer owns the asset).

  2. Operating lease has high CFO because rental income is an operating CF. But for direct financing only interest revenue is considered operating CF.

  3. Operating lease has lower CFI because the entire rental income goes into operating. Whereas direct financing the portion of the payment that is principal is considered an investing inflow…

#4

Thank you both! yes

#5

Lessor’s perspective:

  1. NI is only lower in the early years in an Operating lease, and it’s lower due to the depreciation expense. Total NI over the term of the leased asset is the same.

  2. CFO is higher in an Operating lease because in a Direct Financing lease, the only the interest portion is considered CFO. The principal portion (reduction in lease receivable) is considered CFI.

  3. There is no CFI in an Operating Lease, thus it’s lower.

Edit - Oops looks like I was a bit slow. Took me me awhile to type this up due to distractions and other answers already came in. Cheers!