Week 5 - Leases Flashcards
Reasons for leasing a car & NOT leasing a car
Lease
1. LOWER monthly payments
» b/c just paying for right of use and have to return car after contract ends (not buying the car)
2. Avoiding depreciation
3. Always driving a new car
4. Limited ownership responsibilities
5. Potential tax benefits for businesses
Don’t lease
1. Usage RESTRICTIONS
» to avoid losing value of co’s car
2. Absence of equity buildup
3. NO OWNERSHIP
4. Long-term costs
Operating lease - BS and I/S effects
- Full risk at LESSOR
+ Responsibility/OWNERSHIP of asset at Lessor
eg. Tesla bears full risk of repair and maintenance - essentially renting
- BS no effect
-
I/S
Revenue
- LEASE EXPENSE (part of operating expenses)
Financial lease - BS and I/S effects
- Full risk at LESSEE
+ Responsibility/OWNERSHIP of asset at Lessee - implicitly a LOAN to purchase the car
- BS recognition of Lease ASSET (b/c used to produce economic benefits)
and Lease LIABILITY (b/c there are expenses associated, monthly payments)
» also accumulated depreciation & LIABILITY AMORTISED by (payment - interest expense) -
I/S
Revenue
- DEPRECIATION EXPENSE (b/c NCA)
- INTEREST EXPENSE (b/c NCL)
^significant BS effect and significantly more expenses, affecting ratios
^all these differences simply due to OWNERSHIP
2 fundamental implications of Operating leases
*Leasing is now a major source of Financing for firms
- Provide HIGHER DEBT capacity
> can borrow more money b/c no liabilities - Allow for flexibility in ADJUSTING PRODUCTION capacity -> for efficient operations
eg. aviation industry relies a lot on leased aircrafts, if sudden increase/decrease in passenger numbers
Why was there a reform in Lease Accounting from IAS 17 to IFRS 16?
+ real effect of acct. rules
Management of diff. entities has DISCRETION to choose between the type of lease although economically identical contracts
- which reduced COMPARABILITY of fin stt.s
- Now (almost) everything is a FINANCIAL LEASE
Real effect
- Firms reduce investments b/c want to reduce expenses & want to be more careful with larger BS effect
- but this hampers economic growth
The ‘bright line’ test
If leasing for LESS than USEFUL LIFE -> Operating lease
{If leasing until end of useful life -> Financial lease}
IAS 17 - Financial lease main steps
- Calculate value of asset (LHS)
» LHS = RHS (payments made to acquire asset)
» include concept of Time value of money; find annuity factor and then Implicit Interest Rate (IIR) - Calculate INTEREST EXPENSE = liability * interest rate
- Reduction in Obligation, over time as we pay
- Balance of obligation under finance lease
» the more interest expense we pay, the lower the liability gets over time - Also calculate DEPRECIATION EXPENSE
- BS Lease ASSET + LIABILITY
Note: total expenses for Financial lease in the first few years are usually higher than Operating lease (which is just the no. of periods * interest payments)
2 exceptions for IFRS 16 (new standard) - Operating lease under what conditions?
- Short-term leases (<= 12 months)
- Low-value leases
For financial leases, what does Amortising lease liability refer to?
Amortising lease liability = Cash flow payment - interest payment {interest expense}
Formula for Annuity method depreciation
= annuity {the annual payment} - interest expense
