- CFA Exams
- CFA Level I Exam
- Topic 3. Financial Statement Analysis
- Learning Module 25. Non-Current (Long-term) Liabilities
- Subject 8. Accounting and Reporting by the Lessee

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**CFA Practice Question**

Assume U.S. GAAP. At the beginning of the year, a lessee company enters into a new lease agreement that is correctly classified as a finance lease, with the following terms:

Lease term: 5 years

Appropriate discount rate: 12%

Depreciation method: straight-line basis

Estimated salvage value: $0

Annual lease payments due at the end of the year: $100,000

Lease term: 5 years

Appropriate discount rate: 12%

Depreciation method: straight-line basis

Estimated salvage value: $0

With respect to the effect of the lease on the company's financial statements in the first year of the lease, which of the following is most accurate? The reduction in the company's ______

A. cash flow from operations is $72,096.

B. pretax income is $72,096.

C. cash flow from financing is $56,742.

**Explanation:**The present value of the lease is $360,477.62. (n = 5, I = 12%, PMT = $100,000) 12% of the original PV is $43,257.31, which represents the interest component of the payment in the first year. The difference between the annual payment and the interest is the amortization of the lease obligation included in cash flow from financing. $100,000 - 43,257.31 = $56,742.69

Depreciation is $360,477.62 / 5 or $72,095.52, so the total reduction in pretax income would be interest plus depreciation, or $115,352.83. Cash flow from operations would be reduced by the amount of the interest only because the depreciation would be added back to determine cash flow from operations.

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**User Contributed Comments**
3

User |
Comment |
---|---|

pulkitm |
But interest paid is always included in CFO under US GAAP |

ashish100 |
This makes 0 sense. Like chill out with complexity. Life's too short bro. |

alexa821 |
any idea how to get 360 477 with the calculator? mine doesnt arrive at this number (tried both END and BGN mode) |