I have been reading Non Current Liabilities and have a couple of questions. It would be great help if someone could please explain. Firstly, why is interest payement an operating cash flow and not an operating expenditure? It doesn’t really make sense. Secondly, in US GAAP, there are two types of leases, sales type lease and direct financing lease. In the former, present value of lease payments are greater than book value. While in direct financing lease, the two values are equal. My question is, why would a firm get into a direct finance lease if it isn’t getting any profit?
You’re correct: it doesn’t. It’s one of the stupid rules of US GAAP that you have to memorize.
From the viewpoint of the lessor.
Whether a lessor reports a lease as a sales-type lease or a direct financing lease depends on the nature of the lessor’s business:
- Sales-type leases are usually used by manufacturers of the asset (e.g., Lexus leasing a car)
- Direct financing leases are usually used by dealers (e.g., ABC Auto Leasing buys a Lexus, then leases it)
In a direct financing lease, the firm is getting profit, but that profit is in the form of interest income, rather than in the form of profit margin on a purchase. The profit is the same either way.
Thank you S2000magician!
Correct me if I am wrong,
In a sales-type lease, the firm recognises a profit in the period it leases the asset while in a direct financing lease case, the firm earns an income (interest income) over the lease period.
Thanks again!
That’s correct.