CFA Practice Question

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CFA Practice Question

On 7/1/2016, Grove Company signed a 15-year building lease that is reported in their financial statements as a capital lease. If Grove paid all monthly lease payments when due, how should the company report the effects of this lease in the financing activities section of their 2016 Statement of Cash Flows?

A. As outflow equal to the 2016 principal payments only
B. As outflow equal to the 2016 principal and interest payments on the lease
C. As inflow equal to the present value of the future minimum lease payments on 7/1/2016, less the principal and interest payments made in 2016
D. The lease payments should not be reported in the financing activities section
Correct Answer: A

Recording the lease itself would be classified as a simultaneous non-cash investing and financing activity, while the interest expense portion of the lease payments would fall under operating activities.

User Contributed Comments 12

User Comment
kalps Interest payment comes under operating activities and the capital payment under financing activities
haarlemmer This is classical! I like it!
jainrajeshv Nice One! Exam time review
Mikael Don't get it. I answered D. I Thought this was a non-cash activity (acquiring assets through a capital lease) and this should be disclosed in a separate schedule as part of the statement of cash-flows or in footnotes to the financial statements. For the interest expense portion, I agree: they fall under the operating activities.
wankoo Building Lease=Debt(borrowed money to lease)=Financing activity. Thus, answer A
gill15 So if the building was purchased from cash it would be CFI but in this question the building has nothing to do with anything because its reported on the BS as Capital lease only?
Arent almost all long term assets purchased from borrowing money and therefor always gonna be CFF?
gill15 Here's a very similar question from CFA books
On Dec 31'st company issued a $30000 90 day note at 8 percent to pay for inventory purchased that day. What would be on company's cash flow for year.
Ans. $30000 decrease in operations. The increase in inventories would decrease cash flow from operations. The issuance of short term debt is a financing issue.

my problem with this is that the initial transaction is a non-cash transaction. Nothing should be in CFO. Once repayment of the note occurs then a change in CFF would happen.

Im confused. two questions are similar but giving different results.
Trofimenko I don't understand it too, could anybody give a good explanation?
Saxonomy gill15,
When the company issed the note, they rcvd $30k cash from the investor who bought the note. They used that cash to purchase inventory, thereby causing a cash flow (CF).

Issuing the note = financing CF activity (inflow)
Purchasing inventory = operating CF activity (outflow)
soulfruit When the company having the capital lease, it assumes that the company borrows the money(debt) and buying asset(in this case, building).
So the payment of the principle will be the repayment of debt will be CFF and the payment of interest will be CFO.
Shaan23 Oh. Got it. This is like repaying a loan and therefor CFF.

Interest payments are CFO
kingirm Building lease is identical to renting that building. So as the monthly rent Payments are operating activity, Thé same goes with the monthly lease Payments.
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