Help: Lease Accounting - Effects on LESSEE vs LESSOR, Operating vs. Finance

CFA Level I
#1

So I am using the Schweser Notes and refer to the CFAI books when I really need clarity, but this time I may have hit a wall or it may be a simple misunderstanding.

In the Schweser material - the analysis is on the side of the LESSEE - meaning that certain financial statement accounts like assets, liabilities, are affected differently by the use of an Operating or Finance lease.

From the view of the LESSEE - Assets & Liabilities will be higher with a finance lease in comparison to a operating lease. Or that Net Income is lower in earlier years of a finance lease and higher in later years in comparison to a operating lease.

  • I am a bit confused from the perspective of the LESSOR with some of these things --> I know that Assets & Liabilities will be higher for the LESSOR under a Finance lease as well but there are some accounts that I am unsure about --> EBIT and CFO
  • With a finance lease, CFO is higher for the LESSEE but lower for the LESSOR…Why is this? Is it becasue under a finance lease, only the interest portion is an outflow for the LESSE --> so this means that there is “less of an outflow” to reduce or take away from CFO? While under an operational lease the entire lease payment would be an outflow from operations, therefore taking a larger reduction in CFO? (And vice-versa with the LESSOR --> receives less inflow from operations under a finance lease, and more with an operating lease?

Sorry for the length of the question/comments - just looking for some clarity in terms of how much we will need to understand both sides of the transaction.

#2

For a capital (finance) lease, part of the lease payment is interest, part is principal. From the lessee’s perspective (under US GAAP), interest paid is a non-operating expense, principal paid isn’t an expense at all. The lessee will also have depreciation expense, an operating expense. Interest paid is an operating cash (out)flow; principal paid is an investing cash (out)flow; depreciation isn’t a cash flow. From the lessor’s perspective, both interest and principal received are operating revenues. Both interest and principal received are operating cash (in)flows.

For an operating lease, all of the lease payment is rent. From the lessee’s perspective, rent paid is an operating expense. Rent paid is an operating cash (out)flow. From the lessor’s perspective, rent received is an operating revenue. Rent received is an operating cash (in)flow.

#3

S200magician thank you!

#4

You’re welcome.

(Why did you discount me 90%?)