Leases

[Thepatriot12]

Had this idea while arguing with myself, as I do time to time on how to account for operating leases and leases in general, and wanted to get some feedback. 

 

If we are capitalizing leases and including them within the capital structure of the enterprise, that capital has a cost. More specifically, the property has an opportunity cost. 

 

Lets say I have a building I could sell today for 100,000. I am going to provide the financing by charging an 8% rate. Instead I am going to lease my building so instead of having 100,000 in face value, I have a building. Lets say the lease payment is 8,000. Would it make sense to do the following ?

 

Add an asset on the balance sheet equal to the property value = property borrowed 

Add a liability to the balance sheet equal to the PV of payments to the lessor discounted at its opportunity cost (so this can fluctuate if opportunity costs and lease payments do not coincide) = Ownership interests in property borrowed 

 

Income statement = MCX required to upkeep borrowed property 

 

Statement of cash flows = Opportunity cost payment to lessor aka lease payment 

[spartansaver]

I personally hate how IFRS deals with leases (GAAP is fine, I just ignore the liability - GAAP double punishes with including all the lease expense plus a liability, IFRS has to add a bunch of stupid assumptions that can be manipulated). I think you should understand that a company has leases and what those obligations are, but I think its a waste of time to overcomplicate things with made up assets and liabilities. Why not capitalize that a company uses an ERP system? Its essentially a permanent fixed cost that's necessary for a business. Don't overcomplicate stuff, it's not worth the time and will give you a false sense of being right. You're not going to do well in an investment because you created a bunch of theoretical lease assets and liabilities. 

[Thepatriot12]

6 minutes ago, spartansaver said:

I personally hate how IFRS deals with leases (GAAP is fine, I just ignore the liability - GAAP double punishes with including all the lease expense plus a liability, IFRS has to add a bunch of stupid assumptions that can be manipulated). I think you should understand that a company has leases and what those obligations are, but I think its a waste of time to overcomplicate things with made up assets and liabilities. Why not capitalize that a company uses an ERP system? Its essentially a permanent fixed cost that's necessary for a business. Don't overcomplicate stuff, it's not worth the time and will give you a false sense of being right. You're not going to do well in an investment because you created a bunch of theoretical lease assets and liabilities. 

Yeah, I didn't really gel with the accounting so I was trying to come up with a better way to think it through. You are right that it is a fixed payment required to support operations, but would there not be some justification for it going on the balance sheet given there is a contractual stream of cash flows you have to pay. Maybe it really isn't worth all that fuss, but I do feel like GAAP/IFRS could do better although I am not sure the answer to that is leaving it completely off the balance sheet. 

[Thepatriot12]

I guess as long as you aren't double counting by putting a lease liability and then expensing the lease thereby getting a higher EV then you are fine. Like you said @spartansaver as long as you are aware that the company has those contractual obligations and it is a source of leverage then you can take that into account. If you go the more complicated route, that really shouldn't change your valuation versus just expensing them we just have to relate that valuation to long term debt + market cap - non operating assets.